Franking credits linked to home bias and other pitfalls

13-Mar-2015

By Darin Tyson-Chan

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The Australian equity market’s characteristic of delivering franking credits on dividends naturally led investors to have a home country bias, and could in turn result in highly concentrated portfolios, an investment expert said yesterday.

“If you put a tax advantage into an investment opportunity, people are going to move toward that tax advantage - that’s a reasonable thing for people to target,” Mercer principal Richard Cahill told the S&P Dow Jones franking credits seminar in Sydney yesterday.

Cahill added that bias had the potential to result in portfolios lacking in diversification, and the nature of the Australian equities index made that an issue investors needed to consider.

“You can look at the concentration of the industries in the Australian index,” he said.

“That is one of the concerns people are looking at – whether they’re too exposed to one or two key themes, like the resources market, which of course has been offset by the rise of the banks.

“That’s more about the quality of the index.”

ASX product development manager Brian Goodman said anecdotal evidence suggested many investors, particularly in the self-managed super fund sector, were chasing yield and the associated franking credits in the low interest rate environment, potentially exacerbating the concentration issue.

“In that chase or tilt toward high dividend yield and high franking credit stocks, investors could end up with an inadvertent sector bet or concentration risk they might not otherwise have been aware of, as there are some sectors that pay a higher dividend yield or offer a higher franking credit than others,” Goodman said.

But Parametric director of research and after-tax solutions Raewyn Williams said her firm’s analysis showed some investors had taken into account the risks associated with home country bias and portfolio concentration, and were content they were being adequately compensated in their pursuit of franking credit advantages.

“Our research tells us there are definitely [associated investment] risks … but for some people [using] the information ratio and Sharpe ratio [to measure risk-adjusted return], they still look quite good,” Williams said.

“Our conclusion from that research is that some people will think that those extra risks are well compensated by the franking credit stream.”

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