Seeking the Holy Grail of passive incomeSeveral investment instruments can bring in steady returns for both young and old. -ST
Tue, Oct 23, 2012
The Straits Times
It is the Holy Grail of investing for many of us: Build a big enough nest egg, generate passive income from it and retire comfortably on the steady stream of dividends.
Well, it is not just the Holy Grail for retirees these days; now investors young and old want the reassurance of a steady income after the battering our portfolios have taken in recent years.
The benchmark Straits Times Index may be up 17 per cent since the start of the year, but not before a roller-coaster ride over the past 12 months that left many of us battered and bruised.
Analysts warn that the road ahead looks bumpy, with market movements still likely to be influenced by events and news rather than financial fundamentals.
Mr Kelvin Tay, regional chief investment officer at UBS Wealth Management, says many investors want the safe haven of stable returns in an uncertain market.
"With interest rates so low, much more attention is being paid to what kinds of steady returns they can get in a market like this," he says.
Ms Jane Leung, head of Asia-Pacific at iShares, a subsidiary of asset management firm BlackRock, says that fixed income assets form a valuable core component of diversified portfolios.
"They're favoured for moderate volatility, low correlations with other asset classes and stable cash flows."
These days investors are spoilt for choice when it comes to investing in income assets.
Probably the simplest of all income instruments is the humble bond.
In its most basic form, the bond is essentially a loan made by a lender to a borrower. The borrower pays a lender an interest rate and promises to pay back the money to the lender in full, after an agreed period of time.
For instance, you can buy Singapore government bonds or trade in bonds issued by the Land Transport Authority and the Housing and Development Board on the Singapore Exchange (SGX).
Mr Brian Tan, director of wealth management at financial advisory firm Financial Alliance, says that if people want safety and a steady income stream, look no further than a bond.
The problem is that most bond issues typically come in tranches of $250,000, which put them out of reach for most retail investors.
Similar instruments that are listed on the Singapore Exchange include securities such as perpetual securities and preference shares.
They also pay a fixed coupon rate every year but differ from bonds in that they have different company rights from bondholders.
Companies such as Hyflux and the local banks have issued preference shares through the SGX that pay between 3.9 per cent and 6 per cent a year.
Fixed income funds
A big disadvantage of buying individual bonds is that the investor is exposed to the risk of the company failing.
If the firm goes bankrupt, the investor could potentially lose all the money invested in its bonds.
Buying fixed income mutual funds can help get around this problem.
These funds are typically managed by fund managers, who use their expertise to select a basket of bonds that generate yield.
Mr Tan believes that for retail investors, getting into a fund is probably the best way of getting exposure to bonds.
"Most investors don't have $100,000 or $250,000 sitting around to invest in the bonds of just one company," he says.
"So funds are a good way of getting exposure."
But mutual funds are not perfect. They do suffer from underperformance, depending on the skill of the manager.
The other issue is that they charge relatively high management costs, ranging between 0.5 per cent and 1.5 per cent a year, depending on the asset class and the type of fund.
A fairly recent type of fund, however, drastically lowers the costs of investing with the fund and mostly eliminates underperformance.
Called exchange-traded funds (ETFs), they track indexes, both equities and fixed income, directly. This means that ETFs do not underperform the overall market, but neither do they overperform.
Last year, iShares listed four new fixed income ETFs on the SGX which directly tap the Asian fixed income market.
One is the iShares Barclays Capital USD Asia High Yield Bond Index. Its yield is 7.55 per cent and it charges a management fee of 0.5 per cent. It has returned 17.02 per cent since last December.
Mr Gary Dugan, private bank Coutts' chief investment officer for Asia and the Middle East, says that ETFs should be seriously looked at as an alternative to pure bonds as they are both low-cost and easy to access.
Asset management firm Franklin Templeton's director of retail sales for Singapore and South-east Asia, Mr William Tan, says that index products lose the ability to benefit from an additional source of returns through currency management.
"In an actively managed fund, portfolio managers are more nimble and able to react to changing market conditions and they can adjust the duration of a bond fund as necessary," he says.
High dividend stocks
While income tends to be associated with bonds and fixed income instruments, experts also point out that high-quality dividend stocks can also form part of an income portfolio.
Mr Dugan says that stocks should form part of any portfolio, even if it is income-focused.
This is because some stocks pay higher dividends than bonds, while allowing for potential capital gains.
Analysts are mixed on whether Reits are still good buys.
Mr Dugan and Financial Alliance's Mr Tan believe they are fairly priced, given the rally over the past 10 months, and they are cautious about buying them.
But UBS' Mr Tay says that one should buy Reits based on what they offer and not so much whether prices have risen.
"It's really about quality rather than how much prices have run up by," he says.
Outside of Reits, JP Morgan Asset Management's global strategist Geoff Lewis says that it is a good time to diversify into solid dividend-paying stocks.
"We don't think it's too late in the day to get into the theme of income investing. In the current environment of low interest rates, high yields have thrived even while default rates remain low," he says.
"We like firms that can pay a good starting dividend but with the potential to grow both their business and ability to pay good dividends."
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