Jane Shoemake, Investment Director of the Janus Henderson Global Equity Income Fund, discusses the diversification that investing beyond Australia’s banking sector can provide.
Dividends paid by the Australian market are concentrated to a small number of companies, with the 20 largest dividend paying companies accounting for approximately 80% of the dividends paid by the entire market. Chart 1: Top 20 dividend paying companies and their contribution to their market’s income

Source: Datastream, MSCI, Factset, Société Générale, as at 30 June 2017.

The financial sector is the largest contributor, with the ‘Big Four’ banks dominating payments, accounting for 45% of all dividends paid.

Table 1: Top ten ASX dividend paying companies

Name	Sector​	​% of total dividend
Commonwealth Bank of Australia​	​Financials	​14%
​Westpac Banking Corporation	​Financials	​12%
National Australia Bank Limited​	​Financials	​10%
ANZ Banking Group Limited​	​Financials	​9%
BHP Billiton Limited​	​Materials	​4%
​Wesfarmers Limited	​Consumer Staples	​4%
Macquarie Group Limited​	​Financials	​3%
​Telstra Corporation	​Telecommunication Services	​2%
​Scentre Group	​Real Estate	​2%
​Transurban Group	​Industrials	​2%
Total​	​	​62%

Source: Datastream, MSCI, Factset, Société Générale, as at 30 June 2017.

There is significant reliance on the banks to continue paying dividends at current levels for the dividend yield of the wider market to be sustained. Whilst we don’t believe there is an imminent threat to the outlook for Australian bank dividends, we do believe that it is prudent as an investor to diversify risk and ensure there is not an over-reliance on any one stock or sector to provide income. The suspension of BP’s dividend post the 2010 Macondo disaster is a salutary reminder of the impact that unforeseen events can have on supposedly reliable dividend paying companies.

Outlook for Australian banks relative to overseas banks

The Janus Henderson Global Equity Income Team (Team) manage a number of strategies, including ones where Australian stocks can be held. Currently there is no exposure to Australian banks despite the high yields available, with the Team preferring some of the US and European banks. The recent weakness of the Australian bank sector has led the Team to review this position, with the following conclusions:

• The stocks look expensive on a price-to-book basis (trading at around 1.5x to 2.3x) when compared to their US and European counterparts. (The banks held in our portfolios trade at price-to-book ratios between 1.2x to 1.6x);
• Dividends are attractive, but dividend growth is expected to be negligible given already high payout ratios of around 80%*. Despite stringent capital requirements, dividends have been maintained, with ANZ the only bank to cut its dividend (down 12% in 2016). Dividend growth however has been lacklustre;
• Capital ratios are currently around 10%, up from 8-9% in 2014^, and on an international basis compare very favourably with their peers. However, capital ratios are improving elsewhere in the world and whilst the recent announcement regarding common equity tier 1 capital (at least 10.5%) was less punitive than expected, Australian banks remain under regulatory scrutiny. This was highlighted following the announcement of the introduction of a banking tax on balance sheet liabilities;
• Revenue remains under pressure due to competition, lower loan growth (particularly in mortgages where there is a cap on new interest-only mortgage lending) and other macro-prudential policies. This is in contrast to overseas peers where growth is forecast to improve from its current low levels;
• The slowdown in Australian economic growth and the over-extended housing market remain a concern with regard to bad debt levels.

Australian banks are high quality businesses and their current return on equity is attractive relative to the majority of their international peers. However, return on equity levels are expected to improve at European and US banks, whereas there are concerns that the returns Australian banks can achieve have peaked. Our Team’s view is that we can find more attractively valued banks with decent dividend yields, good growth prospects and improving return on equity levels elsewhere in the world.

^{* Citigroup data, as at 30 June 2017.
^ Bloomberg data, as at 30 June 2017.}