What’s on the income menu in a yield-hungry world

People invest for all manner of reasons but their goals can be boiled down to just two: income or growth.

In practice, of course, most investors will want a mix of both income and growth in proportions according to their risk appetite and specific life situation.

Growth assets tend to be ‘riskier’ investments such as shares while NZ investors have historically derived much of their income from the ‘safe’ haven of bank term deposits (TDs).

But the division between ‘income’ and ‘growth’ assets is not always so clear-cut: many shares, for example, pay regular dividends while bonds can experience capital growth.

Investors leaning to the income side of the spectrum – be that because they are retired or simply prefer a regular cash-flow from their assets – have had a much tougher time of it in recent years.

Since the onset of the global financial crisis (GFC), officially dated to September 2008, interest rates across the world have fallen dramatically. Over that time the NZ official cash rate has dropped from a high of 8.25 per cent to the current stubborn low of 1.75 per cent.

NZ investors no longer have the luxury of drawing a handsome income of more than 8 per cent simply by plonking all their money in TDs.

Along with the rest of the world, New Zealanders have been forced to look further afield for their yield as the price of safety becomes too expensive.

Effectively, income investors have been forced to take on more risk to maintain a similar level of return. And in NZ a number of funds have sprung up to meet that huge demand for higher yields but with some constraints around risk.

However, it’s important that investors look through the ‘income’ label to clearly understand what assets those funds are exposed to – and the kinds of risks involved.

Broadly speaking, income funds come in three different flavours:

  • Share funds – that invest mainly in dividend-paying stocks (although they usually have discretion to invest in some fixed income assets)
  • Bond funds – with a high exposure to corporate bonds and other fixed income assets; and,
  • Diversified funds – which actively allocate to asset classes with income-producing features (for example, listed property or infrastructure).

InvestNow houses about 10 examples of income funds that span all of these labels. (Importantly, this excludes a host of regular fixed interest funds that – while providing yield – invest more in lower-yielding government bonds to restrain risk.)

For instance, the Devon Equity Yield Fund aims to “maintain the dividend yield and capital value in real terms” by investing in a “select portfolio of approximately 25 – 35 New Zealand and Australian listed equity securities chosen for their attractive dividend yields, with some growth prospects” – according to the fund product disclosure statement.

The Harbour Corporate Bond Fund, on the other hand, provides “access to favourable income yields through a diversified portfolio of primarily investment grade corporate bond fixed interest securities”.

As an example of the third approach to harvesting yield, the Mint Diversified Income Fund invests in a mixture of cash (or ‘cash-like’ assets), NZ and global bonds, listed property as well as Australasian and global shares.

All three income-investing methods will carry particular risks depending on the underlying assets.

Equity-heavy funds, for example, are exposed to share market volatility and potential capital losses. Listed company dividends can also vary considerably over time.

Likewise, corporate fixed income securities have a higher risk of default than government bonds – with default rates linked to broader economic performance. The success of diversified strategies will depend on the asset allocation skill of the manager – among other factors.

Somewhat ironically, too, as the global search for yield post-GFC has intensified it has been harder than ever to extract higher yields with investors willing to pay more to access income across all asset classes.

Nonetheless, fund managers are adapting to changing conditions to provide income-focused investors with some options. But in a post-GFC, yield-hungry world, income investors need to be more discerning about what they eat.

By |2018-09-28T16:44:03+00:00September 28th, 2018|Uncategorised|0 Comments