IN BLACK AND WHITE

 

Investing for income - Updated

In September I wrote an article on potential income investing options. (Investing for Income -Sep 12) The opportunities for real  returns, or returns after being adjusted for  inflation, were slim at that time. There have been some significant moves since then, which warrant an update of the numbers.

Latest inflation rates (Year-on-Year)

Country

CPI (%)

South Africa

5.6

UK

2.7

Europe

2.2

US

1.7

Source: www.tradingeconomics.com as at December 2012 ex SA which is still Nov12 number.

Summary table of yields:

Asset Class

Geography + Sub asset class

 Income Yield (%)

Possible real return (%)

Cash Deposits*

UK

0.5

-2.20

 

Europe

0.75

-1.45

 

US

0.25

-1.45

 

South Africa

5.00

-0.60

Money Markets**

UK

0.99

-1.71

 

US

0.81

-0.89

 

South Africa

5.52

-0.08

Government Bonds^

UK 10 year

2.04

-0.66

 

German 10 year

1.53

-0.67

 

US 10 year

1.86

+0.16

 

South Africa 10 year

6.31

+0.71

Corporate Bonds^^

Sterling  Investment Grade

2.65

-0.05

 

European High Yield

4.76

+2.56

 

US Investment Grade

2.75

+1.05

 

US High Yield

5.75

+4.05

Equity Div Yield~

UK

3.3

+0.60

 

Europe

3

+0.80

 

US

2.2

+0.50

 

South Africa

3.4

-2.20

Indirect Property~~

Europe

2.68

-0.02

 

US

2.73

+1.03

 

South Africa

6.2%

+0.60

Source: *tradingeconomics.com, ** ft.com+moonstone, ^ wsj.com, ^^ wsj.com + investorintelligence.com, ~ft.com,~~ iShares ETF for US & UK, PropTrax ETF for SA Property. As at January 2012

The general trend indicates that inflation has picked up across the board, although we are still at relatively low levels for all countries on a historic basis. The significance of this is that, even if the absolute income yield on your investments had remained the same, the REAL YIELDS will have fallen further. Simplistically, your money would buy you less of the same goods as it had in September.

Yields on the various income options have not remained static however. If you have kept even half an eye on markets over the last four to five months you will know that risk appetite levels have risen. According to market commentators, this improved risk appetite is largely as a result of a decline in the headwinds or risks relating to the Euro crisis, US fiscal policy uncertainties and an improvement in Chinese economic data.

The asset classes in the table above have reacted in a fairly predictable fashion if we are indeed on a path to continued economic recovery. A long-term sustainable recovery would result in even higher inflation levels and eventually central banks will have to withdraw the unusual stimulus measures.  As hard as it is to believe right now, they will even have to start raising interest rates at some point in an attempt to control the potential for inflation to spike from here.

Cash & equivalents - Interest rates have remained static since September, as central bank actions remain focused on ensuring a recovery. Money market rates have begun to move higher, albeit marginally, which is what will happen as the market eventually prices in interest rate hikes.

Government Bonds – With the exception of SA, government bond yields have risen. Bonds are generally fixed rate instruments, so if investors anticipate a rise in inflation, and subsequently interest rates, they will try and sell their bonds before the fixed return is eroded. Bond prices will fall and yields will rise as a result. South Africa is a high yielding ‘emerging’ country and still relatively attractive to yield seeking investors in the developed world. SA bonds have remained in demand from international investors and yields have fallen slightly.

Corporate bonds – The fact that companies will tend to perform well as the economy recovers means that the greater appetite for risk assets is also evident in  ‘spread compression’ or lower yields in corporate bonds. None more evident than in European High Yield yields, which have fallen by almost 3.5% over the last few months. (Perhaps a little too complex for the current discussion but a rise in government bonds will partially offset a fall in corporate bond spreads as corporate bonds are priced off an underlying government bond.)

Equity - Dividend yields are, if anything, slightly lower too, which means the real yields from equities have fallen since September.  It makes sense that equity dividends yields are lower as stock prices have enjoyed a strong rally on the back of improved optimism. The prices we are paying to gain access to income from equities is higher and therefore the yield will be lower.

Property – I did not include property yields in the initial analysis (was Total Return) but this time around I have used the yield on respective country exchange traded funds (ETF’s) to give an indication of the yields available in the asset class. The rally in property assets has continued and the yields from these funds have fallen over the time period.

 

Please note this write-up does not constitute advice. Contact White Investments if you would like to learn more about your income investment options, both domestically and offshore.

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