Looking at the recent polls and the betting odds, the current opposition look set to be in government following the May election. The market is pragmatic and has started to adjust to this outcome, in particular the proposed changes to franking credit refunds.

In fact, since the Wentworth by-election late last year, whereby an independent Dr Kerryn Phelps won the seat previously held by the ex PM Malcom Turnbull, the topic of off-market buy backs has been front and centre.

It has therefore been no surprise to see that the level of off-market buybacks since then has accelerated, maximising the franking component for the average SMSF investor. Many of the larger companies on the ASX have distributed substancial levels of franking credits with a large (and pleasant) dividend dump for investors.

The impact on investment portfolios will typically be more significant for the SMSF sector, which traditionally looks for income benefits within their SMSF that is in pension phase. The current benefits of receiving cash refunds on imputation credits has led to a generally higher allocation to the domestic equity asset class and some hybrid securities. Given the taxation benefits of receiving income for retirees, it will be no surprise to see a change in the asset allocation within SMSF over time if these changes go through.

As a consequence, there will over time be an increase in demand for exposure to corporate debt, both investment grade and sub-investment (ie high yield) bonds and there will be a steady increase in allocation to these funds going forward.

Some basic asset allocation revision. Fixed income is a defensive asset class. It tends to act as a hedge against your riskier equity asset class, that is, it outperforms when equities under-perform and vice-versa (they have low correlations). Unfortunately, some investors stretch the definition of fixed income, whereby the benefits of the low correlations (the hedge) are diluted. For example, some may suggest that listed “hybrids” are fixed income. Not to be pedantic but hybrids (whereby some distribute franking) are not a substitute for fixed income.

Following the proposed changes to the treatment of imputation credits, the demand by investors for corporate debt as an investment will increase, therefore these funds which are managed by specialist fixed income credit managers will grow in size over time. This will be a natural adjustment by the investor to the proposed policy changes.

A quick reminder that fixed income as an asset class consists of a number of sub components that include: sovereign debt (ie. Australian government debt), semi-government (ie. state governments), supra-nationals (entities backed by governments such as the World Bank, Asian Development Bank), investment grade credit and sub-investment grade (high yield/higher risk) credit. A blend of these fixed income exposures is recommended for the typical balanced investor.

The SMSF investor segment is a significant savings pool in the local market and it will continue to remain so. They know what they want and do not like policy changes that impact their savings. The proposed changes to the treatment of imputation credits by the opposition have upset many, however the pragmatic investor will adapt and search for income in retirement via other asset classes. Fixed income as an asset class will be one of the beneficiaries of the proposed changes going forward. Make sure that you take the time to understand the exposures before you invest.

George Boubouras

CIO  |  Atlas Capital
Director  | Salter Brothers Asset Management (SBAM)

As seen also in Herald Sun, Thursday April 11, 2019.

Salter Brothers Asset Management Pty Limited: ABN 33 119 833 760, AFSL 308971 is the trustee of all Salter Brothers Funds.