Searching for income
One of the key aspects that has emerged from better inflation management and the recent economic crisis has been the very low level of interest rates on both savings and loans. Yet keeping interest rates low is a multi - faceted tool. Besides the...
One of the key aspects that has emerged from better inflation management and the recent economic crisis has been the very low level of interest rates on both savings and loans. Yet keeping interest rates low is a multi - faceted tool. Besides the above, low interest rates make it difficult for savers to grow their nest egg to the magic amount, which will give them the peace of mind to retire. For example €10,000 invested at 7.5 per cent p.a. (pre tax) more than doubles in 10 years whereas the same amount invested at five per cent will increase by 63 per cent over the same period. Savers must either save more or start earlier to achieve the same result.
On the other hand investors who have already reached their retirement age and now have the income from their investments to supplement their pension will find that the interest rate returns that were factored in when they started to save, no longer apply. In fact it is likely that their expected income will have fallen substantially, possibly by over 30 per cent. Their choice is a stark one – learn to live on less or start to eat into your capital to bridge the gap between the expected income and the actual income. There is another option and this entails looking to the bond market to try and structure a portfolio that will give you a higher return. Gone are the ideas though of unrealistic returns when a conservative portfolio easily yielded six per cent + p.a (see table).
This table indicates the returns that are available, on average, from euro denominated bonds. For example 10 year Malta Government stocks yield four per cent gross, whereas German bunds yield 1.65 per cent for the same period. Clearly there are other yields that are available, some of which look downright sexy. The trade off however is always risk. This comes in two folds. It is either a credit risk which means that there is a chance that the entity that has issued the bond folds and capital is lost, or there is the risk associated with the length of time of the bond.
Consequently should investors wish to achieve a higher rate of return it is clear from the table that the option is to either go for a lower rated bond, i.e. higher credit risk, or a longer dated bond i.e. greater interest rate risk. A slight deviation from this in the investments grade bond is with respect to the financial sector. Here yields are above the levels that can normally be found in comparative non financial bonds. This is because there are greater risks currently associated with the financial sector.
It is wise therefore to build a portfolio that reflects the risks that as an investor you are able to take. Be conservative and be realistic. Do not risk your assets if you cannot absorb the potential loss. Investing in a bond with a lower rating or perhaps with a longer duration is no bad thing per se. However in my opinion it requires a greater level of explanation from the advisor and a greater level of sophistication on the part of the investor.
Additionally local bonds can be used. Currently you will find better yields than those available in comparable sectors overseas. There is a reason for this. Think risk, but on this occasion not necessarily a credit risk but more a liquidity risk, i.e. the risk of not being able to sell the investment should you wish to do so. This is a major weakness on our local exchange, but one which investors need to be more aware of and price into their thinking.
Eur Fixed Income Asset Classes Yields
| 1-3Y | 3-5Y | 5-7Y | 7-10Y | >10Y | |
| % | % | % | % | % | |
| German Government Bonds | 0.1 | 0.4 | 0.9 | 1.4 | 2.4 |
| Government Bonds | 2.4 | 3.0 | 3.6 | 4.0 | 5.0 |
| Malta Corporates | 5.9 | 5.7 | 5.3 | 4.3 | n/a |
| EUR Investment Grade Corporates | 2.7 | 3.2 | 3.6 | 4.1 | 4.2 |
| EUR Financials | 3.4 | 3.7 | 4.5 | 4.7 | 4.3 |
| EUR AAA | 1.0 | 1.7 | 2.0 | 2.6 | 3.0 |
| EUR AA | 1.4 | 2.1 | 2.6 | 3.1 | 3.5 |
| EUR A | 2.4 | 2.9 | 3.2 | 4.0 | 4.1 |
| EUR BBB | 4.1 | 4.6 | 4.8 | 5.2 | 5.1 |
| EUR High Yield | 9.7 | 8.9 | 8.8 | 8.9 | 8.3 |
| EUR BB | 8.5 | 7.1 | 7.6 | 8.4 | 8.3 |
| EUR Single -B | 13.5 | 10.5 | 9.5 | 8.6 | n/a |
| EUR CCC | 19.9 | 22.0 | 15.6 | 12.5 | n/a |
| Global Emerging market Sov & Corp (avg. rating BB+) | 6.2 | 5.7 | 6.1 | 5.7 | 6.0 |
| EUR Emerging Markets - Sovereign ( avg. rating BB+) | 4.3 | 4.8 | 5.8 | 5.5 | 11.7 |
| EUR EM Corporates (avg. rating BBB) | 4.0 | 4.9 | 5.7 | 5.4 | 4.7 |
Source: Coutts Bank, Bloomberg, Curmi & Partners
Curmi & Partners Ltd are members of the Malta Stock Exchange and licensed by the MFSA to conduct investment services business.
This article is the objective and independent opinion of the author. It is based on public information and should not be viewed as investment advice in any manner. The value of investments may fall as well as rise and past performance is no guarantee of future performance.
www.curmiandpartners.com
Mr Curmi is managing director of Curmi and Partners Ltd.