FSA Guide to the Art of Income Investing - HK Version 2016 | Page 4

INTRODUCTION Editor’s viewpoint THE ART OF INCOME INVESTING to load them with assets. Investing for income requires constant vigilance. The source of the income and its quality will vary over time making this a highly dynamic investment process. With interest rates at record lows and elevated volatility, managers are being tested but are proving that opportunities still exist in a variety of assets. S trong market volatility that began late last year and has spilled over into 2016 is telling us that investors are pessimistic about the global economy. Indications are that the four US interest rate hikes the US Federal Reserve had planned this year are unlikely. But regardless of the number of rate increases, the widely held expectation is that any increase will be gradual and puny. Europe and Japan are likely to lower rates, if anything. Low interest rates are here for years, some might say decades. Add in volatile global markets after several consecutive years of low volatility, and that dims the outlook for investment returns. The stage is therefore set for income investing as an investment philosophy: Getting products to pay the investor regularly, just like the bank used to pay interest on savings. Products are everywhere, but selection is not easy. Identifying investments that generate predictable cashflow is both skill and art. Will the income generated be there next month? Conditions change rapidly. The best example is government bonds, which used to provide safe, consistent, longterm returns. Now $6trn in government bonds globally have negative yields. 4 Of course, bond yields can still be found -Greece and Brazil government bonds are paying high single digit returns – but the trade off is higher risk. The same is true in high yield corporate issuance, a re-labeling of what used to be called junk bonds. Much depends on understanding not only the company’s ability to service its debt, but how macro forces impact on the issuer. Balancing yield and risk are at the core of income investing. Drew Wilson Editor, Fund Selector Asia In equities, the choice for regular income has been listed companies with a long track record of increasing payouts. The ideal is 3-4% dividend yield plus 3-4% underlying growth of the stock. A variety of other types of equity instruments also offer income. Business development companies (BDCs), real estate investment trusts (REITs), master limited partnerships (MLPs) and royalty trusts are among them. Investors can also look at the many flavours of exchange traded funds that invest only in dividend-paying corporates. A relatively new byproduct of the low interest rate environment is the yieldco, a public company formed by the parent company to hold operating assets. Yieldcos generate predictable cashflow and pay dividends, but also give growth because the parent companies continue Dividend-paying equities, like bonds, need to be carefully examined. Corporates can cut dividends. According to research firm Markit, aggregate dividends payouts are expected to grow at 5% this year compared to 9.3% over the prior four years. The lower growth is due largely to commodities companies – traditionally high dividend payers – chopping their payouts due to rock bottom commodity prices. And when the dividend is slashed, the stock price typically follows. Ref lecting these themes, the following articles look at some of the challenges of income investing and suggest how investors can maximise sustainable income with an eye on balancing yield and risk. FSA 60% MSCI World High Dividend vs S&P 500 3 year % 40% 20% 0% 28/2/13 31/12/13 31/10/14 Index : MSCI World High Dividend Yield GTR Index : S&P 500 GTR in US 31/8/15 Fund Selector Asia Guide to the Art of Income Investing March 2016 www.fundselectorasia.com