ETFs (and other ASX-listed Products) that Pay Monthly Distributions

“If we have food and covering, with these we shall be content.” ~1 Timothy 6:8

Some time ago I wrote about the Betashares Australian Dividend Harvestor Fund (HVST), which as of now has a very high dividend yield (about 9%) and pays monthly distributions. Monthly distributions are very convenient if you are living off passive income because, for day-to-day expenses such as food, it is more convenient to receive your payment more frequently. Most ETFs pay distributions every quarter, which is quite a long time to wait.

That being said, quarterly or even yearly distributions may be convenient for spending on things you spend less frequently on e.g. a holiday. Suppose you had $100k invested returning 4% dividends. This is $4k per year but paid monthly this would be $333 per month, which means if you wanted to save up for a holiday you’d need to take that $333 per month and put it in a savings account and wait for it to accumulate to $4k before you take an annual holiday. However, if you put that $100k into an ETF that pays yearly distributions, then you’d get $4k once a year, and when you get your $4k, you can go ahead and book your flights and hotels online. The fact that the ETF pays yearly rather than monthly distributions acts to force you to save for those expenses that occur yearly (typically a holiday).

Therefore, I think it is useful to have a mixture of distribution payment frequencies to match what you spend your money on. However, when it comes to financial independence, you shouldn’t focus on holidays first. You should focus on the necessities, and even though I am an atheist, I like to quote 1 Timothy 6:8 in this instance: “If we have food and covering, with these we shall be content.” In many translations of the bible, it claims that you should be content with “food and raiment,” and the word “raiment” is often translated as referring to clothing, but really raiment refers to covering, i.e. not only clothing but also shelter i.e. four walls and a roof over your head. Why am I talking about food and coverings? Because generally food and rent consist of payments we make frequently. For most people, food spending consists of going to the local supermarket to buy e.g. bread. Rent or mortgage payments are usually monthly payments to the landlord or bank. As such, it is better to have monthly passive income if you’re living off passive income while covering the necessities of life.

In my greed to secure monthly passive income to cover the cost of necessities such as bread and almond milk, I invested a reasonable amount of money into HVST, which at the time was paying about 12% dividend yield. However, the problem with high yield funds is that they are high risk funds as well. In fact, most ASX-listed products that pay high monthly passive income perform quite badly in terms of capital preservation. This may be due to the rising interest rate environment. Many high-yield ETFs and LICs that have managed to achieve reasonable capital preservation have been those that pay quarterly distributions e.g. VHY, IHD, STW, and BKI. The reason I believe this is the case is that stocks provides higher yield than e.g. bonds, but there is greater risk in stocks. Unless we are talking about variable-rate bonds, most bonds are fixed-income products, e.g. a government bond pays you a fixed coupon amount. You can therefore rely on this coupon always being paid. There is little uncertainty. Dividends from stocks, however, may vary depending on market volatility and business activity. For example, recently BHP announced it was buying back shares and paying a special dividend thanks to the sale of a US shale asset to BP. If a fund manager holds BHP, it may receive a huge dividend one day and then the next month may receive little dividends. If economic conditions are challenging, dividends may be cut. As such, if a fund manager were relying on stock dividends to pay monthly distributions, there may be times when dividends are low, which means that in order to maintain the high monthly payout, the fund needs to eat into original capital.

When focusing on financial independence, it make sense to focus on the necessities first, i.e. food and raiment rather than holidays, and given that it is more helpful to have monthly passive income to fund these expenses, I believe it is necessary to look instead at medium-yield (not high-yield) exchange-traded products that pay monthly distributions. Assuming food costs $300 per month and rent costs $700 per month then this means you need $1000 per month for necessities, which means $12k per year. You only need $150k invested earning 8% to get this. This is the allure of high-yield funds. However, with high yield comes high risk, so a medium-yield fund may provide a good compromise.

Remembering that investing has a risk-return tradeoff, and remembering that food and raiment are necessities (you cannot live without food and covering), we should not rely on high-yield high-risk investment to fund necessities. We should at least rely on medium-yield medium-risk investments to fund necessities.

I make these comments because recently I have purchased Betashares’s hybrid ETF (HBRD), which pays about 4% monthly. I have found that HBRD pays very reliable income, almost the same every month whereas virtually all other investments pay variable passive income. Looking at the Bloomberg price chart of HBRD below, you can see that HBRD (in black) is somewhat correlated to the XJO (represented in orange by the STW ETF) but with a lower volatility (or lower beta). This makes sense because hybrids are lower risk than stocks but are riskier than bonds. (Hence they are hybrids as they have bond-like and stock-like characteristics.)

HBRD (in black) has lower volatility than XJO (in orange)
Source: Bloomberg

In fact, Betashares seems to have learned its lesson from HVST and have introduced a slew of other medium-risk ETFs (e.g. CRED and now BNDS) that pay monthly distirbutions to complement their existing inventory of low-risk income ETFs (e.g. AAA and QPON) and high-risk income ETFs (HVST, YMAX, EINC, and RINC).

Below is a table of ASX-listed products (mostly ETFs, LICs, and LITs) that pay monthly distributions. The products below are sorted by risk/yield. I have used my judgement to classify these are high, medium or low yield. Generally high-yield investments derive income from stocks and pay around 5% to 10% yield, medium-risk investments derive income from hybrids and corporate bonds and pay around 3% to 5% yield whereas low-risk investments derive income from cash deposits and government bonds and pay around 1% to 3% yield. Some of these products invest in highly risky areas e.g. QRI will invest in commercial real estate debt. Note that some of these investments have not been released yet and that this is a personal list that I keep that may not include all ASX-listed investments that pay monthly passive income. If I have missed any, please notify me in the comments section.

ASX TickerNameYield
HVSTBetaShares Australian Dividend Harvester FundHigh
PL8Plato Income Maximiser LimitedHigh
QRIQualitas Real Estate Income FundHigh
AODAurora Dividend Income Trust High
EIGAEinvest Income Generator Fund High
GCIGryphon Capital Income TrustHigh
MXTMCP Master Income TrustHigh
HBRDBetaShares Active Australian Hybrids FundMedium
CREDBetaShares Australian Investment Grade Corporate Bond ETFMedium
BNDSBetaShares Legg Mason Australian Bond Fund Medium
QPONBetaShares Australian Bank Senior Floating Rate Bond ETFLow
AAABetaShares Australian High Interest Cash ETFLow
MONYUBS IQ Cash ETFLow
BILLiShares Core Cash ETFLow

Disclosure: My investments include BHP, IHD, HVST, AOD, HBRD, and AAA.

Betashares Active Australian Hybrids Fund (ASX: HBRD)

I have always been interested in the latest ETFs in Australia. Most people are collectors e.g. they collect stamps, coins, antiques, wine, or wristwatches. I personally like to collect investments. As such I has bought and continue to hold countless investments across many different asset classes. The problem with a passion in e.g. wine or wristwatches is that it may not be profitable (unless the wine or watch is so rare it goes up in value) but an obsession or passion in investments is one you can indulge in without any guilt.

The latest ETF I have researched and purchased is the Betashares Active Australian Hybrids Fund (HBRD). The reason why I have purchased HBRD is because I feel at this stage I have an overweight exposure to stocks, so I want to reduce the risk of my portfolio. However, reducing risk usually involves investing in cash, bonds, or gold. However, these asset classes (with the exception of corporate bonds) pay low passive income thanks to the current low interest rate environment. Investing in HBRD allows me to reduce risk while at the same time getting about 4% or 5% passive income paid monthly.

For a few years now I have been worried about the valuations of stocks and property, but I have been surprised that these assets continue to go up, so the derisking of my portfolio over the last few years has certainly cost me money as I have missed out on large price appreciation. (I also missed out on the cryptocurrency boom as well.) Nevertheless, I have little regrets because I believe in diversification i.e. spreading money across everything. My plan is to gain freedom by slowly building passive income through steady and consistent investment fueled by a minimalist lifestyle. I also believe it is better to be safe than sorry. I’d rather walk steadily towards my goal rather than run there in order to save some time and potentially slip and fall. As they say, everything looks good in hindsight.

What is a hybrid?

All investments have a risk-reward trade-off. The more risk you take, the more potential reward you have. For example, cash or government bonds are safe investments. Government bonds are guaranteed by government. In Australia, cash deposits are mostly government guaranteed as well. However, if you invest in government bonds or cash, you will earn little interest, perhaps 1% or 2% if you’re lucky. Bonds are merely IOUs. If you buy a bond, you are effectively lending money and in return you receive regular interest payments (called a coupon) as well as your money back after a certain period.

In contrast to bonds, stocks are risky investments. Buying stocks allows the stockholder to vote (e.g. for who becomes a director) and allows the stockholder to earn dividends, which are simply payments made by the company to stockholders from profits. Stocks are risker than bonds because bondholders are paid before stockholders. If there is profit made by the company, bondholders are paid first and remaining profit is paid to stockholders. This also applies in the event of bankruptcy. Because stocks are riskier, companies need to pay higher dividends in order to compensate investors for taking on more risk. Dividends from Australian bank stocks such as CBA pay dividends of about 8% currently, but stock prices are volitile and can fluctuate wildly. Although bank stocks pay higher passive income, you are risking capital loss and dividend cuts should the banks become unprofitable.

Hybrids are assets that are a hybrid of bonds and stocks. When you buy a hybrid, you receive regular income as you would a bond. However, under certain circumstances within the hybrid contract, the asset may be converted into equity. All hybrids are different, so it is difficult to generalise. Some hybrids have characteristics that make them more like bonds whereas others have characteristics that make them more like stocks. Regardless, hybrids sit between bonds and stocks on the risk-reward continuum and so can be expected to be less risky than stocks while still paying reasonably high income.

Why buy a hybrid ETF

As explained earlier, every hybrid is different. In order to understand whether a particular hybrid is more bond-like or stock-like, a careful study of the terms and conditions is required. Hybrids are complex investments and as such is suited to active management and oversight by experts, which is what HBRD provides.

Conclusion

Although a good case can be made for active management in hybrids, active management has its issues. You are putting your trust in people, which is generally not a good idea. Nevertheless, I do not intend to put everything into HBRD but will instead spread money across lower risk investments with high passive income. There are another ETF also issued by Betashares that invests in corporate bonds (ASX: CRED). Corporate bonds are higher risk than government bonds thereby allowing higher yields. CRED also pays monthly income, which is very attractive for people who live off passive income (such as myself).

One of the frustrations with hybrids is that there is very little information about it. For example, if you research cryptocurrencies such as bitcoin on the internet, you will find a neverending flood of information, YouTube videos, etc. Bitcoin is a global investment that everyone can access. Hybrids, on the other hand, have few exchanges and are mostly purchased by institutional investors off exchanges. There is little information on the internet about hybrids.

Another consideration is that HBRD purchases hybrids from Australian banks, which are heavily exposed to the Australian housing market. There are currently fears of a slowdown in the property market. Nevertheless, Australian banks do not hold the property itself but rather the mortgages used to buy the property. So long as borrowers keep making their interest payments and paying their fees, revenue should be unharmed. Hybrids are issued all around the world, so the returns on hybrids should correlate with global interest rates. In the recent rising interest rate environment, this should mean higher returns from hybrids but more interest cost for Australian banks as wholesale credit becomes more expensive. Nevertheless, Australian banks do have considerable market power allowing them to respond to rising cost of global wholesale credit by raising interest rates or fees.