In a recent webinar with GFM Wealth Advisory, Djerriwarrh portfolio manager Brett McNeill discussed Djerriwarrh’s investment objectives and why we prioritise the sustainability of our dividend as much as our current yield. We’ve summarised the conversation here.
What are Djerriwarrh’s investment objectives?
Djerriwarrh’s primary objective is to deliver a dividend yield that is above the dividend yield of the share market, also known as the enhanced yield. We want to deliver an attractive total return over time with a balance of income and growth. The way we generate the income is via two sources – the dividend income and the option income.
The dividend income involves us constructing a portfolio of good quality companies delivering sustainable dividends. The option income from primarily writing call options against stock that we own deliver additional income and is a strategy that sets Djerriwarrh apart from many other income products in the market. We only use options to generate the additional income, we do not use them to speculate or hedge the portfolio.
Djerriwarrh leverages options to generate a reliable stream of income, enhancing its yield above the ASX 200. We primarily sell call options on existing portfolio holdings, occasionally using put options strategically. This approach has consistently produced income, generating $12.1 million, $12.5 million, and $14.8 million over the past three fiscal years.
We acknowledge the trade-off between income and future growth. Selling options provides premium income today but may limit potential capital appreciation. Our strategy is to find a balance, generating attractive income without hindering long-term growth.
Our portfolio strategy and option-selling approach has seen Djerriwarrh's recent monthly yield at 1.5% basis points above the market, with a total return close to the market average over the past year to May 2024. This demonstrates our ability to achieve both enhanced income and compelling total returns.
How important is the active management of options in the current environment?
The active management of the options book is a crucial part of our strategy. The stock portfolio to generate the dividend income can be with a buy-and-hold approach that focuses on quality long-term investing, but the options component is different. It requires both strategic and tactical positioning. We need to have the settings right and ensure we are writing enough options to generate the required level of option income.
We need to be reactive to what is happening in the market in response to the daily share price movements across the whole market, sectors, and stocks.
There are also two other components to consider for active management of options:
1. Due to the cash flow dynamics of an options book, a balance sheet with access to debt facilities is crucial. Djerriwarrh, as a standalone listed investment company, possesses this financial strength to effectively manage cash inflows and outflows associated with options activity.
2. Navigating the options market requires significant experience. We have a dedicated dealer with nearly two decades of options trading experience. Djerriwarrh's own 30-year track record in the options market demonstrates our in-depth understanding of this changing landscape.
How is Djerriwarrh positioned in the current economic environment?
As long-term investors, every investment we make has a five-to-10-year view or longer. We avoid chasing short-term market cycles and we don’t trade around the next data point or try to pick where interest rates are going. We focus on building a portfolio of high-quality companies that can survive over our long-term investment horizon.
However our holdings within these companies will change over time because of the impact of the option strategy. Djerriwarrh benefits from income however we might have to sell if the call option is exercised, which, as expected, has been happening in the recent strong market.
Our approach includes letting call options on stocks be exercised as a result of strong share price performance, particularly as evidenced more recently in the banking sector (NAB, Westpac, Commonwealth Bank). This execution allows us to capture profits from rising share prices with the offset being a reduction in our overall holding size when share prices are high.
Similar outcomes were experienced recently in industrial companies like Wesfarmers and JB Hi-Fi, previously part of our Top 20 holdings.
How does Djerriwarrh balance income and growth?
We provide shareholders with an attractive combination of income and growth potential. Our strong dividend yield of 6.3% when grossed up for franking credits is underpinned by a solid track record and a focus on long-term sustainability.
One of the key features of our approach is the active management of our options book. While our stock portfolio prioritises quality companies with a focus on long-term buy-and-hold investing, the options component requires a more dynamic approach. We generate income from the options book while effectively managing risk, allowing us to capitalise on market movements and capture opportunities.
We prioritise the sustainability of our dividend as much as its current yield. Our dividend is fully supported by the company's underlying net operating profit per share. We avoid boosting dividends with one-off capital gains, ensuring a reliable income stream based on our core business activities.
We also maintain healthy franking credit reserves, similar to other established investment companies, further strengthening the sustainability of our future dividend payments.