One way to maximise your investment in the ASX Big Banks (and double your yield)

This interview was taped on Wednesday 19 June 2024.

Most retail investors are in the Big Four banks (and Macquarie Group to a lesser extent) for one main reason - those hefty fully franked dividends. Commonwealth Bank, the nation's largest. has paid out a $2+ fully franked dividend every half year for the last four reports. Meanwhile, the National Australia Bank has not recorded a decline in its half-yearly payouts since mid-2020 when COVID first hit. And although Macquarie Group's dividend is not fully franked, the forthcoming $3.85 per share payout is nothing to sneeze at. 

It's for this very reason that sell-side equity analysts have been left so stumped. CBA, for instance, is one of the most expensive banks by valuation in the developed world. Every sell-side analyst who covers it (bar one), according to FNArena, has it either at a SELL or equivalent rating. Yet, its share price has not declined dramatically. 

But while dividends are fantastic, it is also true that dividends can and do fluctuate. Or, as many investors have learned the hard way, can be eliminated altogether. 

That's where bank bills can be differentiated. Not only are bank bills guaranteed just like any other bond, and can appreciate like a stock, but they can also pay twice the trailing yield of any major bank. It's become such an investment opportunity that income managers like Perpetual's Michael Korber are running into them head-first. He tells us more about the opportunity in bank bills - and floating rate credit more generally in this edition of The Pitch.

Edited Transcript

Why should Australian investors consider exposure to credit markets right now?

Korber: At the moment, floating rate credit is offering really attractive absolute returns. We've got fairly high interest rates, we have got good credit margins, and performance in the sector is doing really well. I think that the absolute return that's being offered, relative to some of the riskier asset classes, like equities etc., is pretty good at this point in the cycle. 

And that return is a predictable return. These cash flows within credit markets are contractual cash flows, they compound in a predictable way. At this point in the cycle, we think the total returns are really strong, the predictability of returns is really high and the outcome for investors is looking pretty good.

How is Australian credit different from global credit?

Korber: The Australian market has evolved more recently, over the last 20 or 30 years, and it has evolved in a very robust legal framework. So the legal framework is very friendly to lenders. In Australia, the economic environment tends to be more stable. We've got a lot of more concentrated corporates. You think Coles (ASX: COL), Woolworths (ASX: WOW), the major four banks. 

The environment is actually less volatile than some of the offshore universe. But at the same time, it's a very sophisticated, legally protected and fairly diverse universe. Offshore, the level of risk is greater. There's more opportunity for diversification, but there's also probably more volatility as well.

Most market participants are sure that the next move for rates will be down. What impact will that have, if any, on floating-rate investments?

Korber: Our view has been that inflation is a stubborn beast and higher for longer is I think a core case. But at some point, that will begin to moderate. Floating rate credit is really good because it doesn't have the capital risk that bond portfolios do. So it tends to follow the economic cycles as inflation moderates returns will moderate, but have a very capital stable, again, a very predictable performance outcome in the sector.

What is a high conviction investment you have in the portfolio?

Korber: Here are a couple of different examples. I think one of the things that we try to do in our portfolios is to embrace the diversity that's available in Australia. We don't invest in narrow sectors. We embrace the whole universe. 

I'll give you one through COVID that we thought was a really good investment and performed well for us - and it gives you some sense of how we look at the market - Qantas (ASX: QAN). It was a volatile business through COVID. They looked pretty tenuous in their creditworthiness, but we had a strong view that they had such a strong market position within Australia that the cycle would eventually support them again and that at a point in time when their prices were very stressed, they would perform and that was a great trade for us. 

More recently, we've seen the banking sector will issue a lot of subordinated [Tier 2] debt. This is the middle rank between the senior deposits and the junior rank that, domestically, we have in the income security space. 

The banks have issued a fair bit of that both in Australia and offshore. We do look at the markets both domestically and offshore, and we certainly saw good opportunities, names like NAB (ASX: NAB) and Macquarie (ASX: MQG) to invest in US dollar subordinated debt, and that's performed very well for us.

You're looking at yields up around 7, 8, 9%, something like that. And I think one of the things that we try to do is to be very active investors. We will try to invest when a particular security is selling at a yield, which is quite cheap and with a view to not necessarily hold it through to maturity, but to see that price improve and to cash out. 

So for example, the NAB and the Macquarie Securities that we held, were 10-year securities, but we held the money for 12 months. Once they recover the valuation, the price improvement is actually much greater than the running yield or the coupon that you're receiving. 

Learn more

The Perpetual Credit Income Trust (ASX: PCI) aims to generate sustainable, regular income by investing in a diversified portfolio of credit and fixed income assets. For further information, please visit their website, or the fund profile below.

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Perpetual Credit Income Trust (PCI)

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