by
Elizabeth Moran | Aug 26, 2014
In a low yielding investment environment smart investors can still boost their returns by taking on carefully selected risk as part of a diversified portfolio.
Three ways that an investor can take on higher risk are by agreeing to part with their money for longer, by accepting weaker rights over the issuer’s assets, or by investing in companies that are more at risk of failure.
The first of these ways, longer terms until maturity, is something that most people will be familiar with from term deposits. These usually pay a progressively higher interest rate as the term increases. A few years ago, this simple strategy was good enough to generate a high medium term return. For instance, Westpac investors were paid an 8 per cent fixed rate return for handing funds over for five years.
Unfortunately, it is not that easy any more with the incremental increase in return for committing to a longer dated term deposit now marginal. A good major bank term deposit rate for one year is around 3.4 per cent, while the five year rate is 3.9 per cent, although a higher 4 per cent if you have at least $500,000 to invest.
If investing for longer is your strategy, bonds now offer a better proposition. For example the Dampier to Bunbury Natural Gas Pipeline joint venture has a bond maturing in September 2015 with a yield to maturity of 3.7 per cent and another bond maturing in five years in October 2019 with a yield to maturity of 4.76 per cent. The extra yield of 1.06 per cent is compensation for investment in the same company over the longer term given there is less certainty about the performance of the company. There is a greater chance something will happen to it, whereas the closer to maturity the more certainty there is for investors.
This theory holds true across all asset classes. Hybrids with longer terms until first conversion or redemption, that if missed can then be perpetual, are greater risk than those with earlier calls and defined final repayment dates.
The second way to get higher returns is by investing in securities lower in the company capital structure, which exposes you to more risk in the event that it fails. Each bank and company has a capital structure which shows the priority of payments in the event of a wind-up. Investments at the top of the ladder are repaid first, while those at the bottom take on the losses first and are most likely wiped out.
This has been a popular option. Swapping major bank term deposits for their shares has delivered great returns over the last year, but there are a number of rungs in the capital structure with varying risks in between that can deliver higher returns without going from one of the lowest risk options to the highest.
The third way to boost returns is to replace investments in low risk companies for companies that are higher risk. Theoretically, across the bond, hybrid and share markets investing in higher risk companies should deliver higher returns. Some of the best returns available in the bond market are from companies that are not rated by credit rating agencies, or rated sub investment grade. Investors can earn much higher returns of over 6.5 per cent but take on higher risk of default or non payment by the company.
A word of caution, returns are directly correlated to risk. The higher the risk, the higher the return should be. It’s very important that you understand what the risks are and make a judgement of the incremental return you need over the lower risk options to compensate.
Copyright The contents of this document are copyright. Other than under the Copyright Act 1968 (Cth), no part of it may be reproduced or distributed to a third party without FIIG’s prior written permission other than to the recipient’s accountants, tax advisors and lawyers for the purpose of the recipient obtaining advice prior to making any investment decision. FIIG asserts all of its intellectual property rights in relation to this document and reserves its rights to prosecute for breaches of those rights.
Disclaimer Certain statements contained in the information may be statements of future expectations and other forward-looking statements. These statements involve subjective judgement and analysis and may be based on third party sources and are subject to significant known and unknown uncertainties, risks and contingencies outside the control of the company which may cause actual results to vary materially from those expressed or implied by these forward looking statements. Forward-looking statements contained in the information regarding past trends or activities should not be taken as a representation that such trends or activities will continue in the future. You should not place undue reliance on forward-looking statements, which speak only as of the date of this report. Opinions expressed are present opinions only and are subject to change without further notice.
No representation or warranty is given as to the accuracy or completeness of the information contained herein. There is no obligation to update, modify or amend the information or to otherwise notify the recipient if information, opinion, projection, forward-looking statement, forecast or estimate set forth herein, changes or subsequently becomes inaccurate.
FIIG shall not have any liability, contingent or otherwise, to any user of the information or to third parties, or any responsibility whatsoever, for the correctness, quality, accuracy, timeliness, pricing, reliability, performance or completeness of the information. In no event will FIIG be liable for any special, indirect, incidental or consequential damages which may be incurred or experienced on account of the user using information even if it has been advised of the possibility of such damages.
FIIG provides general financial product advice only. As a result, this document, and any information or advice, has been provided by FIIG without taking account of your objectives, financial situation and needs. Because of this, you should, before acting on any advice from FIIG, consider the appropriateness of the advice, having regard to your objectives, financial situation and needs. If this document, or any advice, relates to the acquisition, or possible acquisition, of a particular financial product, you should obtain a product disclosure statement relating to the product and consider the statement before making any decision about whether to acquire the product. Neither FIIG, nor any of its directors, authorised representatives, employees, or agents, makes any representation or warranty as to the reliability, accuracy, or completeness, of this document or any advice. Nor do they accept any liability or responsibility arising in any way (including negligence) for errors in, or omissions from, this document or advice. Any reference to credit ratings of companies, entities or financial products must only be relied upon by a ‘wholesale client’ as that term is defined in section 761G of the Corporations Act 2001 (Cth). FIIG strongly recommends that you seek independent accounting, financial, taxation, and legal advice, tailored to your specific objectives, financial situation or needs, prior to making any investment decision. FIIG does not make a market in the securities or products that may be referred to in this document. A copy of FIIG’s current Financial Services Guide is available at www.fiig.com.au/fsg.
An investment in notes or corporate bonds should not be compared to a bank deposit. Notes and corporate bonds have a greater risk of loss of some or all of an investor’s capital when compared to bank deposits. Past performance of any product described on any communication from FIIG is not a reliable indication of future performance. Forecasts contained in this document are predictive in character and based on assumptions such as a 2.5% p.a. assumed rate of inflation, foreign exchange rates or forward interest rate curves generally available at the time and no reliance should be placed on the accuracy of any forecast information. The actual results may differ substantially from the forecasts and are subject to change without further notice. FIIG is not licensed to provide foreign exchange hedging or deal in foreign exchange contracts services. The information in this document is strictly confidential. If you are not the intended recipient of the information contained in this document, you may not disclose or use the information in any way. No liability is accepted for any unauthorised use of the information contained in this document. FIIG is the owner of the copyright material in this document unless otherwise specified.
The FIIG research analyst certifies that any views expressed in this document accurately reflect their views about the companies and financial products referred to in this document and that their remuneration is not directly or indirectly related to the views of the research analyst. This document is not available for distribution outside Australia and New Zealand and may not be passed on to any third party without the prior written consent of FIIG. FIIG, its directors and employees and related parties may have an interest in the company and any securities issued by the company and earn fees or revenue in relation to dealing in those securities.