Financial advisers and investors should look at sustainable dividends rather than the very next dividend when managing risks while generating equity income, according to Merlon Capital Partners.
Speaking at the Morningstar Investment Conference, Merlon’s lead portfolio manager, Neil Margolis, said sustainable dividends meant capital was preserved after the dividend was received.
“To understand sustainable dividends you have to understand sustainable cashflow. To do that you have to have as much history as possible on the company – have they generated cashflow in the past, what’s the macro conditions, what is normal for that company, and has the industry and company’s position changed over the last five or 10 years,” Margolis said.
“Once you understand sustainable cashflows and you deduct debt in full because that’s really important to determine what is available in dividends and that’s a good starting point.”
He noted that when selecting companies, investors should avoid starting with the index as it could have concentration risk.
“We like to think of all companies as equal opportunities to look for the best dividends and that’s a non-benchmark approach,” he said.
“The third thing to manage risk is to use stock specific hedging within the fund to retain 100% of the franked dividends but only have say 30% less downside risk.
“That is something is more difficult for individual investors and advisers to do but something we add on top.”