How overseas stocks can provide franking credits to income investors


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Rising inflation, higher interest rates and slowing economic growth all pose separate threats to the attractive dividends currently being paid by Australian companies.

Income-hungry investors should also note that over 80% of Australian dividends are paid from companies in just four sectors. This forces many portfolios of income investors to be highly concentrated.

The share prices of these companies are exceedingly sensitive to dividend payments, which potentially leaves these stocks under pressure if dividends falter.

dividends listed investment companies

Many income investors are now having to choose between investing in potentially overvalued companies to meet their income requirements, and appropriately diversifying their equity exposure.

Averages can be misleading

Australian dividend yields on average now exceed pre-COVID levels, providing further support to share prices of companies that pay dividends.

But averages can be misleading. A more detailed analysis reveals dividends are highly concentrated in a few well-performing sectors: the Materials sector now accounts for 45% of total dividend payments in the Australian ASX All Ordinaries index, up from 28% at the end of 2020. Including financials, real estate and energy sectors brings the total to 80% of total dividends paid in Australia.

The sustainability of dividends, and share prices, in these sectors is closely linked to global demand for commodities and the health of the domestic property market.

Property is highly sensitive to interest rates, which are now rising. Commodity prices - especially iron ore, LNG and coal - are highly sensitive to global GDP and China's real estate market and industrial production, which are slowing even as China lowers interest rates.

There is a strong case to diversify stock holdings to include quality global companies, which can provide additional sources of income and better spread the risk - but what of franking credits, which are so important to yield-hungry investors?

LIC structure delivers franking credits via global exposure

It's still possible for income investors to access global dividends with franking credits via a listed investment company (LIC) structure.

For example, LIC Pengana International Equities (ASX: PIA) is an international ethical investment company that provides access to global equities, and also has a mandated target to pay shareholders fully franked quarterly dividends. As an Australian company, PIA pays tax on its taxable income, and as it is listed in Australia on the ASX, it means investors still enjoy the benefits from franking credits. Using the PIA example, this currently equates to a yield of over 8% per annum.

LICs have more control over distributing taxable income compared to traditional unit trusts. This is because LICs are not required to pay out all taxable income to investors at the end of each financial year, unlike a unit trust. LICs therefore have the flexibility to smooth dividend payments to investors on a quarterly basis.

So as local dividend stocks increasingly become more concentrated on the ASX, there are also global investment options which yield-hungry investors may consider to diversify and spread their risk.

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Tim Richardson is an investment specialist at Pengana Capital Group, a diversified funds manager known for its innovative global investment strategies, ESG strengths, and unique listed private equity trust. Tim is a CFA charter holder, and his financial services career spans more than 25 years in the UK and Australia with several major institutions in banking, superannuation, and insurance. His main interest is global equities with a focus on sustainable investing.