Where to Find High Yield
12/01/2007 12:00 am EST
Moderator Mark Glowrey, director of Stockcube Research Ltd., and his panel of fixed-income experts took attendees through a comprehensive look at some unique income investments.
Glowery told attendees that fixed-income investments have other advantages besides providing steady income-including the compounding effect of payments, which results in capital growth, as well as their low correlation with typical capital growth investments.
Glowery noted that investors who held fixed income when the tech-stock bubble burst were very happy with the steady returns they made, while tech investors were losing most-if not all-of their portfolios. In determining what kind of assets to purchase, Glowery warned investors who hold cash to exercise caution when choosing the companies that pay the highest interest, as the high yield often equates to high risk. As for high-yielding equities, he recommended that investors opt for companies with price/earnings ratios less than 15x and dividend coverage above 1.5 times earnings.
For the conservative investor, or those with short-term needs, Glowery suggested considering Gilts, bonds issued by governments, including the UK. Although they are not high yielding, they are of rock-solid credit and are utilized by most professional investors, including pension and mutual funds. They don't trade on stock exchanges, are often difficult to buy, and brokers frequently charge high fees for them. Yet, with the tremendous growth in online brokers, they are much easier and cheaper to buy, so they may be suitable for a portion of investors' portfolios.
Glowery then discussed purchasing bonds, suggesting that investors-especially those who intend to just purchase one bond-always buy investment grade (higher than BBB), and the best quality you can afford. If, however, you have a large portfolio of bonds, you, can shop for bargains and buy some higher yield, lesser quality bonds for a small portion of your holdings. And investors with small amounts of money may consider a bond fund.
One last consideration, Glowery noted, is tax efficiency. And with the introduction of iShares, investors have several good vehicles to minimize their tax obligations.
Neil George, editor, Personal Finance,added that today's fixed-income investor has many alternatives to choose from but should be aware that there are various risks involved every time you step away from benchmarks such as Gilts, sterling, the US dollar, and US treasuries. George also advocated that investors consider taking on more risk. He advised that instead of looking at fully valued investments with the highest credit-which only have one way to go (down!), you may want to consider lower-rated companies that might catch on with the investing public, and-in the meantime-pay higher income.
George suggested hybrid income/equity instruments that combine a common stock of an operating company with actual debt or bonds of that company. Examples include Medical Facilities Inc. (TO: DR-UN), which operates outpatient surgery centers in the US, right across the border from Canada, and Keystone (TO: KNA-UN), a Canadian burial services company that operates in the US and Canada.
Oliver Butt, partner, City and Continental, LLC, representing the "dark side" -highly- distressed companies-suggested that investors make sure they buy companies they understand. Many of these high-yielding instruments require hefty minimum purchases to keep out the widows and orphans. Butt recommended that investors consider liquidity and length of holding period before purchasing investments in this arena. Lastly, investors should determine how much they can afford to lose. As with equities; sometimes, there's a story behind these instruments that just makes good investment sense. For example, Butt cited Swiss Air and British Energy as good examples.
Peter Temple, freelance journalist and author, Peter Temple Associates, told investors that preferred shares are attractive. They are last in line to be paid out, one-notch above pure equities, in case of a bankruptcy. Temple noted one positive feature of preferreds is that the dividend is paid after corporate taxes are deducted, so the income is considered 'franked', or what you get in your hand is what you keep. This tax preference means that the yields tend to run at a bit of a premium to gilt-edged stocks. Temple remarked that these instruments are subordinated and not as secure as Gilts. Many are also cumulative, so any dividends not paid as required, will roll up over time. Often overlooked, but priced at a bit of a discount to where they should be, preferreds look interesting.
Temple also discussed PIBs, permanent interest-bearing shares that are typically issued by building societies. They are bonds in all but name with no maturity date. Some are callable, and many are currently yielding 7%-8%. He mentioned two: Northern Rock, yielding over 13%, and Kent Reliance, yielding around 7%. PIBs, like preferred shares, are last in line to picking over assets if a company goes bust (and the UK government is now negotiating with potential buyers of mortgage lender Northern Rock), so make sure you investigate the risk.
David Stevenson, the Adventurous Investor column, Financial Times, discussed structured products, synthetic instruments that are created to meet specific needs that cannot otherwise be met by standardized financial instruments. They are generally targeted toward the wealthy. Stevenson said that one provider stands out-Merrill Lynch-which is packaging products that follow a main benchmark, such as the Dow Jones Euro Stoxx Index, and whose returns depend on the index's reaching specific targets. Stevenson finds them attractive as investors get a coupon, although they are taking on market risk. He also mentioned additional interesting income plays such as utility trusts, corporate bond and Gilt iShares, Deutsche Bank db x-trackers exchange-traded funds, and the FTSE All-Stocks Gilts index.