A fresh look at the Australian shares market, and RDV & RARI reconstitution changes

Last month I reflected on the attractiveness of Australia shares for income seeking investors in the ‘Investing for Income in the 2020s’ note. Today, we look at what has changed since then – and review the recent changes to our two Australian shares ETFs: Russell Investments High Dividend Australian Shares ETF (RDV) and Russell Investments Australian Responsible Investment ETF (RARI).

Australian Shares in April 2020

Encouragingly we have seen the Australian shares market stabilise and volatility start to subside. The market is well off the 23 March low of 4,546 having staged a 20% bounce in the last 3 weeks. However, is this a dead cat bounce or cause for greater optimism than what prevailed last month when Coronavirus cases around the world were accelerating rapidly? What we do know is:

  • The Australian economy, like most other countries, is entering a recession as a result of lockdown related actions by governments to control the spread of Covid-19
  • Unemployment will likely hit 10%
  • Earnings guidance has been withdrawn for many stocks with some companies cancelling dividends
  • Lockdowns will start to be relaxed….

Another feature has been companies racing to raise capital to stay solvent. In the past few weeks, many Australian stocks, such as QBE Insurance, have asked investors to commit more capital through rights offers and placings. Billions of dollars have already been raised to help companies navigate the current crisis, often at very attractive prices for investors – we have been active for both ETFs for several raises acquiring new shares at discounted levels. We expect there will be much more of this to come. The government may also need to step in to support some companies that cannot get the finance they need through the capital markets. Virgin Australia may be one such example (not held in the ETFs).

This capital raising looks set to cap further gains in the share market, at least in the short term. We also know many individuals will be accessing their Super funds early to provide funds to help them through the crisis which will add to the selling pressure.

However, beyond this there is reason for optimism. The huge amount of stimulus governments are providing to keep the global economy functioning should help economies rebound quickly. The hope is the uptick in unemployment is temporary and we see a V shaped economic recovery. This is the expectation of many market commentators and the bounce in share markets reflects much of this optimism. It is also encouraging that the debate has started to shift to the lifting of lockdowns, rather than just the number of cases of Covid-19 across states and countries.

Turning to dividends, how do things look now?

 SandP ASX 200 Profit margins were under pressure coming into this

Source: Refinitiv Datastream, 31 March 2020

Regulators from the UK to NZ have banned their banks from paying dividends during the Covid-19 crisis. APRA stopped short from an outright dividend ban but has encouraged banks and insurers to consider their capital requirements, ahead of shareholder dividend expectations. NAB, ANZ and Westpac, which are held in both RDV & RARI, will all make dividend announcements in the next few weeks. Whilst there are many challenges ahead for companies to generate earnings and dividends, Australian shares remain an attractive asset class for yield over the medium term with the added benefit of franking credits. Our 2 Australian shares ETFs both offer yields above the S&P/ASX 200, next we review how they changed at the recent index reconstitution.

RDV Reconstitution

The RDV portfolio increased positions in Consumer Discretionary and Utilities at the expense of Materials – as can be seen below:

Percentage change in sector weights

Crown Resorts was a new consumer discretionary add, whilst APA Group and AGL were 2 new utility stocks added at the reconstitution. Utilities have been relative outperformers in the recent volatility thanks to their defensive qualities. On the flip side, we sold out of mining services stock Mineral Resources due to lower forecast 3-year dividend growth and higher variability of earnings - both of which counted against the stock in ranking its’ yield credentials under RDV’s methodology.

RARI Reconstitution

Finally, turning to the RARI portfolio rebalance there was a sell of Materials with several stocks, like Mineral Resources, being sold to zero due to less attractive yields and in some cases low ESG scores.

 Percentage change in sector weights 02

Source: FTSE Russell, Russell Investments

A key difference to the RDV changes was that RARI was a net seller of consumer stocks. This was largely driven by the gambling exclusion which does not permit RARI to buy gaming stocks like Crown Resorts and Star Entertainment. RARI has been more affected by companies raising capital and participated in the capital raises for both Southern Cross Media and oOh!Media. Both stocks have rallied very strongly from the price new capital was raised at which is an encouraging sign.

There remains a lot of uncertainty in the market around both price levels and the dividends/earnings companies will generate. Both ETFs offer a diversified portfolio of securities (50 stocks for RDV, 71 for RARI) which will help investors reduce risk and earn attractive levels of income over the medium term in these challenging times.

   View the RDV & RARI
reconstitution update

Russell Investments Australian Bond ETFs

Central bankers have responded to the shock to growth by following the same playbook. Cutting interest rates to zero as quickly as possible, followed up with quantitative easing and other programs to support financial markets.

With a synchronised economic collapse leading to policy convergence, government bond yields have plunged worldwide. The Reserve Bank of Australia cut cash rates twice to 0.25%, the Australian AAA rating will come under monitoring in the coming weeks and liquidity conditions have deteriorated. What’s next?

Our Senior Implementation Portfolio Manager Alistair Martyres discusses recent market reactions for the Australian bond market. He provides insight into the March Russell Investments ETF Reconstitution and shares his opinion on the outlook for the domestic fixed income markets.

   View the Fixed Income
ETF reconstitution update