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The dividend rotation strategy

V. Teckchandani:

Hello, my name is Vishal Teckchandani. I'm Nabtrade's

content editor. I have the pleasure of having with me in the Nab office

Dr. Don Hamson. Don is the founder of Plato Investment Management, and

he's going to share with us an investment strategy that you can deploy

in the market. It's called dividend rotation. Don, welcome. Great to

have you here.

Don Hamson:

Thank you.

V. Teckchandani:

Don, dividend rotation. What is it, and what type of

investors could it be suitable for?

Don Hamson:

Dividend rotation is really a concept of picking up extra

income by trading stocks to capture income. You don't need to earn a

stock for 12 months to get the dividends. In Australia, stocks tends to

pay two dividends a year. You need to earn them for ... Presumably,

you're calling by slots, franking credits, and we've talked about that

in the past. To enable you to capture the franking Credits, you have to

have them at risk for a certain amount of time, certainly at least 45

days, but you don't need to own a stock for a year to get the dividends.

It's a matter of trading in and out of stocks to capture more income

than a static index.

V. Teckchandani:

Okay, so potentially this is more for the active

investor segment.

Don Hamson:

Yes, yeah. Clearly it is very active and can have quite high

turnover. That's something to consider is that it's probably best suited

for low-tax investors who won't pay a lot of capital gains tax, because

it can have tax consequences from this tradition. We would recommend, we

follow the strategy as ideal for people who are on very low tax rates

and, in fact, ideally zero tax rates.

V. Teckchandani:

Okay, so can you walk us through an example of how you

actually do this?

Don Hamson:

Yeah, so CBA, Commonwealth Bank, it's the largest stock in

the Australian market, quite a strong, fully franked yield, it pays its

first dividend ... Well, actually goes X its dividend in February, so

you have to hold around that X date to capture the dividend.

V. Teckchandani:

It buy it a couple of weeks or months before?

Don Hamson:

We tend to buy it a few months before it goes X. Once it

goes X, we actually reconsider whether we want to stay in that stock, or

whether there are other opportunities to get income further down the

track. The way we do it is we're constantly re-evaluating our portfolio.

If we've captured the dividend from Com Bank, we can then look forward

to where's the next significant income payments in the market. It just

happens that Nab and [inaudible] are banks that pay dividends

about three months after Commonwealth Bank. There's a nice opportunity

to think about, "Well if I've got the income from the Commonwealth Bank,

maybe now I can re-deploy my capital and get income out of Nab or

[inaudible]." There's a nice set of almost peers trading in

terms to do that.

We do that quite often with the banks. That means you can capture a lot

more income that just owning Com Bank for the whole year. You need to be

cognizant of things like transaction costs and those sorts of things,

and we've talked about this in that past, you also want to be very sure

that the stock you're buying is going to pay the dividend. There's no

point in chasing the dividend traps or stocks, trading on very high,

unsustainably high yields because you may actually be disappointed.

There are tricks and traps for young players, but if you follow this in

a disciplined process, you can capture, and that's how we capture a lot

more income in the market than they're able to, well, on an after-fee

basis, have about 50% more income than what the market would deliver. We

can generate about 9% income after fees versus S&P 200 has delivered

about 6%. Both of those numbers are gross of franking. That's a good way

of increasing yield on a portfolio.

V. Teckchandani:

Sure. Okay, from an investor's perspective, it's quite

important to plot it out, if you will. You've got February reporting

season, which is quite generic. You've got Com Bank and many other

players. You've got the May bank earning season. Then there's August.

Then there's October/November.

Don Hamson:

Yes, so you have this nice patent of dividends. If all

stocks went X on the same day, which actually in Japan in the March

quarter, they actually all pretty much go X on the same day, doesn't

give you a lot of opportunity to rotate between stocks.

In Australia or in most countries, you have a nice spread of dividends

across the year, and so you can capture more income by trading your

portfolio. You've got be cognizant of things like the 45 day rule.

V. Teckchandani:

Yeah, absolutely. Once you've deployed the strategies,

so say a couple of weeks or months before you buy a stock, is the idea

just to get rid of it as soon as X date?

Don Hamson:

It depends a lot. We re-evaluate, but that doesn't mean we'll

actually sell the stocks. Some stocks like, for the last couple of

years, Macquarie Bank, we basically have been overweight the whole time.

We might top it up a little bit before it goes X dividend, but we might

still hold that stock ...

V. Teckchandani:

So you're not necessarily selling down entirely.

Overweight on it, you want to capture that dividend, then you reduced it

and redeployed those funds into ...

Don Hamson:

Yeah, yeah. Some stocks we don't even reduce it. We might

actually say, "Well actually we're happy with this stock. We think the

capital growth potential is very strong so why would we sell it."

Others, yes. We bought it to get the income, and we might sell the whole

holding afterwards.

V. Teckchandani:

Okay. Now, you've actually done a study on what's

called the dividend run-up effect. Can you explain more of that?

Don Hamson:

Yeah, so what we've found, we've actually found it both

domestically and globally, is that dividend paying stocks tend to

outperform their local market. In the Australian case, the S&P 200 or

300, if you actually look at stocks that pay dividends, in the couple of

months before they go X dividend, and this is on average, it doesn't

mean every stock, but on average, dividend paying stocks tend to

outperform other stocks in the couple month period.

V. Teckchandani:

Why is that?

Don Hamson:

I think one of the reasons why it is is because there is,

particularly amongst retail investors, they like income. Now, if you're

considering buying a stock to get the income out of Com Bank or National

Australia Bank, you need to buy it before it goes X dividend. Once it

goes X dividend, you've lost that opportunity to capture that dividend.

There's quite a lot of purchasing by retail investors, there should be

some research about this, in the few weeks before it goes X dividend.

If people are buying more of it, they're going to push the price up. Our

research shows that that price appreciation actually stops on the X

date, because now you've lost the dividend.

V. Teckchandani:

The high yield ones are chased more than the ...

Don Hamson:

Generally. You got to get to the extreme and say you don't

want to get sucked into the extreme high yield, then it goes the other

way. There are risks associated with the strategy. We think it's best

deployed on a well-diversified portfolio, not just three or four stocks.

If you just do it on three or four stocks, you've got a lot of stock

specific risks.

V. Teckchandani:

Do you only stick to stocks with 100% franking, and do

you avoid anything with less?

Don Hamson:

No, we're agnostic [crosstalk ]

V. Teckchandani:

So like CSL?

Don Hamson:

Well, the issue about CSL is it's a great company from a

long term perspective, but it's got a very large dividend yield, largely

unfranked, and I think it is unfranked at the moment. You're not going

to get much income by rotating through that. We tend to rotate through

stocks that have high yield, and the preference is the franking credits,

but we also do it for stocks that don't have franking. It's not all

about franking. Like the [inaudible], and some of the

[inaudible] pay decent yields, and actually at different times.

They tend to go X around June when there's not many other companies

paying dividends, so you can capture more income trading those. You want

to get franking credits, obviously.

V. Teckchandani:

Don, thank you so much for taking the time to come in

today.

Don Hamson:

Thank you.

V. Teckchandani:

We hope you enjoyed that video. A lot to learn from it.

Please do consider the risks and the benefits if you are thinking about

doing it yourself. Do remember that this is a strategy that Don actually

employs in his M fund and in his listed investment company, so you can

do your research and consider those. As always, if you are unsure about

what you're doing or don't have the confidence to construct your

portfolio, please do consider seeking financial advice.

I'm Vishal Teckchandani, see you next time.

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