MANY years ago, when it comes to investment yields, one would refer a high-yield investment as a paper that is normally rated below investment grade or corporate bond papers that gave coupon payments with high single-digit or even in excess of 10%.
High-yield papers gave investors a pick-up in yield that was easily between 300bps and 400 bps higher than sovereign papers for the obvious reason and mainly due to higher default risk.
In Malaysia’s context, while we may not have many marketable securities that are rated below investment grade, other than being downgraded, seeking investment papers that gave investors 6%-7% yield or higher was already challenging, even at times when interest rates were “normal”.
With the global push for stimulus and with unorthodox monetary policy practice by practically every other central bank in the world, we have now come to a stage whereby global market yields are so low that investors are wondering where to place their bets just to earn a decent return, with minimum risk.
In Malaysia, the current MGS yields are hovering between 1.8% and 2.5% for papers with maturity period of between 3-year and 10-year papers while local 12-month fixed deposit rates range between 1.8% and 2%. We may get lucky to catch one or two promotional rates that could be even as high as 2.75%. Other than these options, what else could savers do?
Firstly, investors must be reminded that there is no free lunch in this world and when one expects to obtain a higher yield or return on investment, it is associated with higher risk as well. There is no such thing as high yield and low risk, it doesn’t exist in the real world. Now that we got that out of the picture, let’s see what else can an investor do?
Of course, seeking dividend yielding stocks is another example. Typically, respectable dividend income can be earned from real estate investment trusts (REITs), selected banking stocks or even consumer names. However, there remains a degree of uncertainty as to the consistency of these dividend payouts.
A couple of weeks ago this column highlighted retail and hospitality REITs which were impacted by movement control order (MCO) in the Q2 period and hence we had observed lower payouts from most of them. We also saw how lease agreements can be restructured that may alter dividend expectations.
Among consumer names, we have also seen dividends being slashed due to lower business activities while for banks, the elements of uncertainty are even higher as we moved towards the post-moratorium period. Hence, dividend stocks may look attractive on paper, but the reality is, one cannot be absolutely certain.
Hence, what are the options available for investors to gain some respectable yield? Are returns of between 5% and 6% beyond the reach of average investors who are dependent on income stream rather than capital gains? In managing a personal portfolio, the first step in asset allocation is to understand one’s risk tolerance and expectations.
In an environment when cash is yielding less than 2%, investors would have no choice but to assume some level of risk. While the equity market does provide returns other than dividends in the form of capital gain, that future realisable gain is only an expectation and is never cast in stone.
Some individual investors are a bit more sophisticated but this too comes at a price as some of these assets pushed by private bankers could look attractive at first but they may not yield the expected returns consistently. One could also venture into alternative assets like gold or cryptocurrencies but these assets are again pure capital return asset class and not income yielding.
What about properties?
Traditionally, property has been an asset class among investors as the long-term appreciation of the underlying asset is given based on expectations of scarcity, location, brand and value and as a natural hedge against inflation. At the same time, investors can earn a decent yield based on sustained rental income but that yield today has now dropped to well below 4% and in some cases ranging from 2.5% to 3.5% only.
Hence, this too will not meet yield seekers’ expectations. In addition, property owners have to ensure that their properties are well maintained and fully tenanted during the course of the year. In the current economic climate, even finding a tenant for a property in a prime location is already challenging and the vacancy period is getting longer due to the glut that we have now, especially among residential properties and in the high-end market segment.
Some investors are looking at alternative assets and this include peer-to-peer (P2P) lending and co-investing platforms. In P2P, investors are allowed to invest as little as RM50 to as much as RM50,000 and earn a decent yield of between 11% and 12%.
P2P is of course a higher risk investment as small and medium enterprises (SMEs) with relatively weaker credit standings make up the bulk of the borrowers’ profile. Default rates could run as high as 3%-4% and depends heavily on the robustness of individual P2P platform’s credit assessment processes.
In addition, the levels of transparency vary considerably across the different P2P platforms and could make it challenging for investors to assess the associated risks. In the P2P space, the idea is to identify the stronger platforms and diversify into multiple note programs to ensure risk is spread out and the incidence of default is reduced.
On paper, the P2P platform is ideal for individual investors as it could provide a decent pick-up in net yield to 7%-8% once a diversification strategy is deployed. Nevertheless, with the challenging economic conditions, the historical default rate of between 3% and 4% may not be realistic as this could easily doubles, leaving investors vulnerable to lower net yields.
In co-investing platforms, these are also relatively new in our region but as investors, the return profile may vary. In some cases, investors are rewarded based on certain payout structures while in others, investors may be treated like any other shareholders.
Some of these co-investing platforms have also moved towards the property market, especially in the commercial real estate. Here, investors pool their resources together for a specific asset and the sponsor, which is typically a company that has some sort of expertise in the field, basically targets an asset, prepares the funding structure and oversees the investment over the time horizon, which can be as short as one year to as long as three to five years.
Typically, the sponsor would use a platform to raise capital, which is mostly a special purpose vehicle (SPV) and has exit plans for its investors. In this platform an investor receives some sort of coupon payments which can range between 6% and 8%
Globally, co-investing in real estate platforms is gaining traction as more investors come to appreciate how the ease of diversification and flexible investment ticket sizes can augment their investment strategies. As a testament to the appeal of their value proposition, such real estate co-investment platforms in the US have grown tremendously in the past decade despite the US being one of the most developed and extensive REIT markets in the world.
Some of the popular platforms out there are CrowdStreet and DiversyFund, which are US-based. Closer to Asia, Singapore is beginning to see the emergence of these platforms too and they include RealVantage, which was launched last year by veterans from the real estate private equity space.
A check on RealVantage’s website shows several recent assets that were structured for an Australian industrial property and a Manchester-based opportunity to capitalise on the residential sector undersupply. Investors in these structures too carry some risk and of course they include currency risk, exit risk, interest rate risk and the inherent business risk of the underlying commercial asset. Similar to P2P investments, it is of paramount importance that investors go with the stronger platforms run by professionals with the right credentials and track record.
At a time when yields are compressed, individual investors hungry for yield perhaps would need to revisit their asset allocation as the days of high yield are numbered and the only way to achieve targeted respectable returns is to diversify away from traditional asset classes and move towards the alternatives. But of course, the key is always not to put all your eggs in one basket but to also diversify within the alternatives.
Hence, for investors to gain some pick-up in yield from benchmark market rates, a portfolio that targets the traditional asset classes (equities, fixed income, cash and money market funds, and real estate) must have a decent allocation to the alternative asset classes and this include into precious metals, P2P, co-investment opportunities and private equity investments.
The sophisticated investors could even explore more alternative assets, especially in the currency, structures, and derivatives space.
To conclude, it is likely that the current low interest-rate environment will be with us for a period of time and it is imperative for investors to relook their portfolio and re-strategise their asset allocation to include more asset classes and alternatives. Failure to do so will result in investors being stuck in a low-yielding environment and run the risk of not being able to meet their long-term investment objective, be it for retirement or building up a nest for the future.
Pankaj C. Kumar is a long-time investment analyst. The views expressed here are the writer’s own.