With investment grade bond yields at current levels, some income seekers appear increasingly willing to take on lower quality credits in a bid to maintain the same absolute income. They do so with the central assumption that bonds are a ‘safe’ asset class. Local investors may be conditioned by the fact that we have yet to have a bond failure in the local market, though one assumes investors in Argentina have sobered up. I take the view that if one cannot afford to forego income, much less palatable is a capital loss.

We favoured companies less exposed to the eurozone- Martin Webster

If bond yield compression is taken past a certain point, there will come a stage when similar income streams can be derived from dividends paid by relatively high quality names. In many cases dividend streams are appreciably higher than the yield on the same names. ENI, for example, offers a yield which is almost 300 basis points above its own credit – a record. This could be deemed a safer investment, despite the income being derived from a ‘riskier’ asset class. Ultimately, what is most risky is overpayingfor the income stream one is purchasing.

A current theme we are pursuing is selecting a basket of equities which offers an attractive and diversified income stream. Last January we discussed some selection criteria for the basket. These included a historic, and sustainable, dividend yield of at least four per cent. (We eliminated companies which were overtly expensive, even if they cleared the dividend hurdle.) The company had to be reasonably easy to understand. We eliminated banks. We eliminated serial empire builders which appear more interested in growing the size of the business than growing shareholder value, and translating that into dividends. We favoured companies which were less exposed to the eurozone, although we made an exception for utility type companies. (Investors in the eurozone are uniquely exposed to the risk that political idealism will thwart rational economic developments, with the consequent depression on returns.)

We eliminated shares in companies which are typically illiquid – this precluded local shares. We eliminated any company that looks good on paper, but for some qualitative reason we do not feel comfortable about it, its management or the space in which it operates. (This reflects our belief that there is much more to investing than reducing it to a sanitised exercise in mere mathematics.)

The table shows the outcome for stocks on that watch list.

During the year, we held positions in Novartis, Tesco, Royal Dutch Shell and Vodafone. We exited our Tesco investment, and now favour Roche over Novartis. We are happy to hold Royal Dutch Shell, though we are less comfortable with our holding in Vodafone given its exposure to the eurozone and the potential for the negative economic effects of the political idealism referred to earlier.

Our other favoured high yielding stocks for 2013. This does not constitute investment advice. What is deemed to be an attractive investment taken in isolation may not be suitable for an individual investor’s specific circumstances. It should be noted that at any point in time our favoured stocks may change – the table reflects the current position.

I wish all our readers a prosperous and healthy 2013.

www.curmiandpartners.com

Curmi & Partners Ltd is a member 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. The value of investments may fall as well as rise and past performance is no guarantee of future performance.

Martin Webster is head of equity research at Curmi and Partners Ltd.