Time to rethink your yield investment strategy?

Share markets might still be flying high but that has made it increasingly difficult for yield investors to find shares that meet their yield objectives.

Australia’s banking sector – long a happy hunting ground for those who like a combination of strong yield and capital growth – is a great example of how difficult that has become.

Commonwealth Bank (ASX: CBA) is the undisputed outlier, having enjoyed such a strong share price rally that its dividend yield is a paltry 3% – well under the term deposit rate available inside the bank which are up to 4.3%.

It is a similar story for Macquarie (ASX: MQG) which has a trailing yield of 2.74% compared to a one-year term deposit of 4.5%.

The picture brightens a little for National Australia Bank (ASX: NAB) which comes in flat at around 4.4% for both but Bendigo and Adelaide (ASX: BEN), Westpac (ASX: WBC) and ANZ (ASX: ANZ)  all offered a slight premium trailing dividend yield compared to their term deposits.

Banks disappointing on the yield front

Of course, we are comparing apples and oranges here – the term deposit is a guaranteed risk-free return while the dividend yield is the amount of profit distributed to shareholders from running the bank.

However, the point remains that these numbers have moved decisively in favour of term deposits even when you factor in the franking credits that come with the dividends on bank shares.

It is not just bank shares either.

Other markets beating Australia for yield

The overall dividend yield of the Australian share market has fallen to just 3.8% from 5.3% in 2022, which has left Australia now trailing offshore markets including Hong Kong, Singapore and Indonesia on dividend yields.

Some analysts are warning that this yield compression may not even stop if official interest rates start to decline next year, as anticipated after the latest inflation figures.

What has been happening is that the market reacts to these interest rate cuts and simply drives up the share prices of companies that might benefit, such as banks,

This is why the PE ratio (price to earnings) has remained elevated at around 27 times compared to the long run average of 17 times, with earnings actually declining along with dividend yields while share prices have continued to climb.

The earnings yield remains below 4%, which is quite low.

Is this a fad or a structural change?
Obviously, it is impossible to accurately predict the future but the burning question is, will the Australian share market continue to morph into a place where capital gains are produced in favour of high dividend yields?

In other words, are we in the process of going through a structural change or has the combination of high inflation and higher interest rates simply produced an unusual aberration which boosts share prices?

I suspect there is a bit of both going on as the ASX moves towards other larger markets that prioritise profits and capital gains over dividends and market investors also adapt to the changing and unusual economic situation.

For the investor searching for yield, it is not going to be a simple situation of swapping out bank stocks for another sector.

Time for a sell-down strategy?

Instead, it might be time to consider alternative strategies like selling down some well performed shares periodically to produce extra cash rather than simply relying on dividends – which would have been a sound strategy during the current share price boom.

There are also some diversified yield ETFs around to consider such as Vanguard Australian Shares High Yield ETF (ASX: VHY), which yields a whisker above 5% and offers some diversification, the Vanguard Australian Property Securities Index ETF (ASX: VAP), which mirrors the ASX 300 property trusts Index and has a current running dividend yield of 3.6% or even a conservative cash option such as Betashares Australian High Interest Cash ETF (ASX: AAA), which distributes around 4.4% at the moment, with monthly payments.

Property trusts could continue to do well as interest rates fall, so they are certainly worth considering as yield investments that offer growth potential as well.