Getting the best bang for your buck in the downturn

In the boom years, capital gains were the priority for investors. Now it’s all about regular income and liquidity

IF THE LAST decade was all about capital gains – and how quickly you could make them – now investors are looking for options that also produce a regular income.

“The market isn’t interested in capital gains, only investments at the moment,” says Jerry Purcell, a director of Augusta Investment and Asset Management. “There are just two things on investors’ minds – regular income and liquidity.”

But what is income investing? “The way we describe income investing is to try and favour assets that have a sustainable yield,” advises Richard Batty, global strategist with Standard Life Investments in Edinburgh.

In this regard, there are a number of assets to consider, but also important is the tax treatment of the underlying asset. “If you have a high income strategy, then you have to look very closely at tax structure,” advises Ian Quigley, director of NCB Wealth Management.

After all, if an investment produces an income, it will typically be liable to tax at your marginal rate – which could be more than 50 per cent – as opposed to capital gains tax at 30 per cent. But there are ways of avoiding this tax rate, such as opting for a collective investment scheme, whereby the income is rolled into the fund and tax is liable only at exit.

But why bother with income investing when you can earn 3 or 4 per cent annually on deposits?

As Quigley points out, some people might think that everything is rosy and that they don’t need to look for anything further. “But they need to be conscious going forward of the real return rather than nominal returns. There is an argument that loose monetary policy in the US and UK will result in some level of inflation,” he warns.

In this respect, experts believe that income investing can protect against inflation. So what are the options?

Commercial property funds

For many investors, chastened by their experiences during the boom and bust of the Irish property bubble, investing in this asset class might be the furthest thing from their mind. However, according to Batty, it can be a way to securely beat inflation.

“Our three-year view is that property can give you a near 5-6 per cent yield a year,” he says. Of course, where the property is located is key, and Batty notes that Standard Life is currently favouring commercial property in the UK and US. In the UK, there is also a demarcation between the top-tier, prime London market, which continues to perform, and the second-tier regional markets, which are more affected by the downturn in domestic demand.

However, while investors may be able to rely on property funds for a decent yield, they are likely to only benefit from modest gains in the short term. “The big capital gains are probably behind us,” warns Batty.

For Irish investors, investing in dollar or sterling markets also brings a currency risk, although some property funds run by Irish managers hedge against this risk for an extra charge.

Purcell may beg to differ, however, pointing out that the funds his firm offers in German commercial property are performing well.

A particular downside of property funds can be their relatively illiquidity – as was evident during the bust when investors discovered that they couldn’t withdraw their money from several Irish funds.“It can be the nature of the asset class, as it takes time to trade in and trade out of it,” agrees Batty.

However, a way to diffuse this risk is to opt for in-demand markets. “There is a lot of demand from overseas investors for sterling assets. The fall in the value of the currency has made property very attractive for euro investors. It’s an AAA economy and is seen as having safe-haven status,” he says.

Purcell has reacted to the demand for liquidity by restructuring his firm’s funds, allowing access after 12 months.

“People want to know that they can have access to funds if they need it sooner. They are sceptical about the possibility of putting money away for long periods of time for capital growth,” he says.

Summary

Pros: Steady yield that will beat inflation, with prospect of capital appreciation in the medium to long term.

Cons: Property funds can be illiquid and can incur hefty management charges.

Options: Irish Life UK Property Fund; Zurich's European (Ex-UK) Property Fund

Fixed income

Traditionally one of the first ports of call for investors, a fixed-income product such as a bond can offer a regular return in the form of an interest rate.

For Batty, while the peripheral euro-zone countries are offering investors a high return on their debt at present, he says a less risky – and more lucrative – option is to consider corporate bonds.

“To our mind, the balance sheet of many corporates is better than some sovereign nations,” he says.

He favours investment-grade and high-yield corporate bonds offered by US companies, saying they offer “good prospects”, with yields of 7-8 per cent.

“While the caveat is that they are risky assets, they are also quite smooth-performing assets,” he says, adding that corporate risk is lower in the US with evidence that the economy is slowing picking up.

If you’re on the lookout for some investment-grade or high-yield options, remember you will need to consider smaller names, with the larger blue-chip multinationals rated higher and thus offering a lower return.

For investors intent on capital preservation – at the expense of yield – German government bonds might be a steady option, but they could cost money in the long run.

“Over 10 years, it’s a guaranteed way of losing your nominal capital,” says Nigel Poynton, director of NCB Wealth Management.

Instead, he suggests investing in emerging markets’ sovereign debt, again adopting a diversified approach by looking for a manager with specialism in the area, due to the potentially higher levels of volatility.

Summary

Pros: Depending on the category, fixed-income products can offer a more assured return than equities.

Cons: The higher the return, typically the higher the risk.

Options: Rabodirect Robeco High Yield Bonds; Templeton Global Bond Fund.

Dividends

Rather than hoping that markets rise, if you want some return from your equity investments sooner rather than later you could consider dividend-paying stocks. However, it’s not a strategy without risk as those who depended on their dividends from Irish banks will have discovered when they stopped paying them.

Typically, it’s the more mature types of companies that offer a higher dividend, so appreciation prospects may not be as high as for younger, fast-growing companies.

When picking out stocks, you could go for particular companies, or opting for a fund might be a safer option. The iShares EuroSTOXX Select Dividend 30 fund, for example, is currently yielding 5.8 per cent.

Opting for the highest-yielding sector, however, is not always the wisest solution. As Poynton points out, telecommunications stocks such as France Telecom, Telecom Italia and Telefonica, have all been towards the high end of dividend yields – but are now faced with weak profit outlooks and lower earnings.

“You need to look at the sustainability of the dividend, growth in dividend, and the cash flow of the company,” he says.

Poynton points to another advantage of dividend-paying stocks, that they typically perform well in a low-growth environment.

“They tend to perform better than the broader market in bear markets, and provide you with a bit more insulation because you have a consistent income stream,” he notes.

“They also usually have a higher earnings quality, and are historically shown to have more stable returns.”

Pros: You can earn a return even when markets are falling.

Cons: Firms can cut or drop dividends anytime.

Options: S&P 500 Dividend Aristocrats (only includes stocks that have followed a policy of increasing dividends every year for at least 25 consecutive years); iShares EuroSTOXX Select Dividend 30.