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Last week, I looked at some non-bank/non-resource/non-Telstra/non-property trust stocks that pay a reasonable income and are relatively defensive. The five stocks from five different sectors average a yield of 4.2%, which with franking of 80%, gives a grossed-up rate of 5.6% (see five income favourites).
This week, continuing the income theme, here are some listed alternatives to term deposits.
There is nothing wrong with term deposits. Government guaranteed investments (up to $250,000 per investor per financial institution) paying a regular income. And you can still earn up to 1.75% if you shop around (for example, RaboDirect is paying 1.75% for a 12-month term deposit and a 5-year term deposit, ME Bank is paying 1.60% for 6 months).
If you are an income investor and are not happy about the interest rate on term deposits, then you will need to go up the risk curve. Lower rates are here to stay, so the only way to increase your return is to take on more risk.
Risk means that you could lose some or all of your capital. If capital preservation is your main goal, then taking on more risk is the wrong strategy.
However, if you are prepared to “chance your arm”, you can increase the return by taking on riskier investments. Here are 4 ASX listed riskier alternatives to term deposits. These are ordered by “riskiness” (my assessment, from least risky to most risky, and excludes growth assets such as shares and property).
The biggest borrower in Australia is the Federal Government who issues Treasury Bonds. After that you have the States, our major banks, and large corporations.
With the Reserve Bank acting in the secondary market to target a 3-year government bond yield of just 0.25%, yields have crashed and treasury bonds are pretty unattractive. The 5-year bond is yielding 0.37%, while 10 years is around 0.85%.
State Governments pay a little bit more, banks more again and corporations – it depends on their creditworthiness. Suffice to say, there is not much on offer of investment grade quality yielding over 1.5%.
To get any return, you will need to go up the credit curve (take on more credit risk) or buy longer-term bonds (which increases interest rate or duration risk).
You can of course buy individual bonds through fixed interest brokers (these often won’t be investment grade or “secure”), but it is hard (not impossible) to get a diversified portfolio.
A relatively easy option is to consider a couple of the fixed interest exchange traded funds (ETFs). I like the ones of shorter duration that take on a little more credit risk – so iShares Core Composite Bond ETF (ASX: IAF) or Vanguard’s Australian Fixed Interest Index Fund (ASX: VAF) would be my pick. They are both yielding around 0.87% pa, although because they have holdings in bonds that were issued with higher coupons, running yields just over 3.0% pa.
Blackrock’s iShares has recently launched an ETF that tracks an index of investment grade corporate bonds. Under ASX code ICOR, the iShares Core Corporate Bond ETF has a yield to maturity of 1.44% pa.
Be wary about some of the terminology when it comes to fixed interest. If you are a holder to maturity, the only metric that counts when comparing bonds of the same term is ‘yield to maturity’. Terms such as ‘running yield’ are mathematically meaningless. They were invented by bond salesmen in the days before calculators – and had its origins in the USA where even to this day, calculations are based on a “year” having 360 days (rather than 365 days). Remember, if you pay $105 for a bond, you only get back $100 when it matures – you need to factor in the $5 capital loss.
I categorise bank hybrid securities as “risky” fixed interest because if the bank gets into serious trouble, you will probably lose about 80% of your capital. Some people refer to hybrids as ‘equities’ because they form part of the bank’s capital, but unlike normal shares they have absolutely no upside. You will never get more than your $100 back.
They are complex instruments – so if you don’t understand them or don’t want to understand them, don’t invest in them. ASIC’s MoneySmart website can help.
One way to access the market and obtain a diversified portfolio is through Betashares Active Australian Hybrids Fund (ASX: HBRD). This is managed by Christopher Joye’s Coolabah Capital. The downside is the management fee of 0.55% pa.
If you do buy individual hybrid securities, try to build a diversified portfolio with multiple issuers. Here are some points to note:
Infrastructure is an asset class that has both growth and income characteristics. If investing in specific infrastructure stocks such as Sydney Airport (SYD) or toll road operator Transurban (TCL), you are arguably taking on more equity risk than income risk. If you invest in a portfolio of infrastructure stocks, some of the specific equity risk will be diversified away.
Because Australia only has a handful of large listed infrastructure companies, these portfolios are typically global in orientation. Three of the larger ASX listed stocks that provide access to a portfolio of global infrastructure companies are:
Argo (ALI) and Magellan (MICH) are actively managed, whereas VBLD is a low-cost ETF passively tracking a benchmark index (the FTSE Developed Core Infrastructure). MICH invests in a portfolio of 20 to 40 infrastructure stocks and hedges the currency risk. ALI uses Cohen & Steers from New York to manage the portfolio, which ranges from 50 to 100 individual securities. The currency exposure is not hedged.
Dividend or distribution yields for these three stocks should be in the order of 3.0% pa.
MICH and VBLD employ the open-ended quoted fund structure and the price at which units trade on the ASX should be very close to their underlying NTA (net tangible asset value). ALI is a listed investment company and is currently trading at a discount to NTA of around 8.5%.
These are long term investments, so your investment time frame should also be long. If interest rates do go up at some stage, these stocks are likely to be impacted.
The listed credit funds got hammered in COVID-19 market selldown, down about 40% to 45% in price terms at their lows. They moved from trading at a small premium to NTA into steep discounts, as investors flocked to safety and credit spreads widened. A collapsing oil price and fears about the property market heightened concerns.
Since late March, they have enjoyed the benefits of the recovery. Prices have rallied on the back of improving investor sentiment and a fall in credit spreads, the latter driven in part by actions of Central Banks (for example, the US Federal Reserve purchasing corporate bonds). Discounts to NTAs have narrowed, now bunched tightly in the 5% to 10% range.
There are eight ASX listed credit funds. These are:
These are diversified funds investing in developer senior and mezzanine loans, corporate loans, residential mortgages and global high yield bonds. Most pay monthly interest, targeting as high as 8% pa.
As illustrated by the price volatility over the February to June period this year, they are definitely “higher risk”. This means that it is really important to understand what the credit fund is investing in, the duration of those investments, the level of diversification, the domicile, and the underlying liquidity of those investments. Typically, corporate loans, mortgages and developer loans are not liquid.
Finally, a word to the wise. If you are investing in any security or fund that pays a higher return than a government guaranteed term deposit, then you are automatically taking on a riskier investment. This means that the likelihood of losses has increased, and in many cases, should be expected.
Two golden rules. Firstly, never invest in something that you don’t understand. Read the Product Disclosure Statement or Information Memorandum thoroughly, and don’t be afraid to ask the promoter questions. There is no such thing as a dumb question when it comes to investing your own money. If you aren’t satisfied with the answers, don’t invest.
Secondly, invest in moderation. The adage “don’t put all your eggs in the one basket” survives for a good reason. The riskier the investment, the less you should consider investing. Diversify across product, manager/issuer, security and asset class.