Issue: March / May 2013

In search of higher yields

Don’t blindly “dash to trash”, advises Sanlam Investment Management head of retail Candice Paine.

New yield environment? Low yield environment? Bond investors the world over are grappling with what this means for them and how they should respond.

In a post sub-prime crisis investment world, official interest rates have reached historic lows as a result of the unprecedented monetary policy easing that has been implemented in the hope of kick-starting global economic growth. It looks like rates could remain at these lows for even longer. But what that means for bond yields, nobody really knows.

Against this backdrop, the only way bond investors are likely to survive and thrive in this changing fixed-interest investment landscape is to know their stuff and adapt their investment strategies accordingly.

So the million-dollar question facing many investors: what to do about it? Well, you have a number of options:

  • Stick with your current fixed-interest allocation or exposure;
  • Shift focus to higher-yielding assets to achieve a pick-up in return; or
  • Shift exposure to cash and/or equities.

Should I stay or should I go?

Those considering whether to maintain their current fixed-interest allocation need to take into account that, if yields stay at current lows, their income distributions will remain lower than in the past; and if yields rise, they could potentially face capital losses.

Seeking higher yields

Within a lower-yield environment, there’s a temptation – and often a real need – to seek out higher yielding assets, such as corporate bonds (which offer a wide and growing array of choice) and emerging-market bonds (which trade at premium of two percentage point to US Treasuries, considered the world’s risk-free benchmark rate. But the particular risks and attributes of these assets need to be considered carefully because they do change the risk/return profile of a portfolio.

Searching even further afield

For risk-averse investors concerned about the potential risks encapsulated in historically low yields, cash obviously offers the comfort of capital security – but exposes the investor to the risk of inflation eroding returns over time.

Cash battling to outpace inflation

Cash battling to outpace inflation

There are also opportunities to achieve higher yields outside the asset class altogether – by getting exposure to high dividend-yielding stocks or portfolios. But there are risks here too. In SA, forward dividend yields compressed sharply during the year to trade below 3%; below their long-term average of more than 3,2%.

Looking forward: what’s a reasonable return expectation?

Given these structural changes underway in the fixed-interest environment and the strong returns the asset class has delivered in the past – globally a top performer for the past three decades it’s important to manage your expectations regarding what is likely to be a reasonable return going forward.

The key to getting all you can out of the asset class going forward will lie in stepping out of your comfort zone, taking advantage of the opportunities that are undoubtedly out there to boost yield, and most importantly being cognisant of other potential risks you may be introducing to your investment portfolio – and managing these carefully yourself or leaving it up to experts.