Despite the bursting of the dot.com bubble and the fall in stock markets post-11 September, investors who shun equities in favour of income-based investments may be missing out on growth opportunities
Since the dot.com investment bubble well and truly burst in September 2000, many investors have been focusing on investing for income rather than growth. With equity markets uncertain, particularly in the aftermath of 11 September last year, all too many clients of advisers are re-considering whether they actually want exposure to equity markets at all, let alone how much.
While these reactions are perfectly natural and understandable, it is essential that advisers help set the markets' reaction to these momentous events into context, educating their clients and enabling them to assess risk more realistically and accurately.
Advisers must help clients to take a more dispassionate view of the markets and range of investments available, setting them into a proper context for serious discussion and consideration.
It is important to remember that, even now in our current low inflation/low growth economic and investment environment, the single most prevalent ' and dangerous ' risk to long-term savings and investment is inflation, the inexorable decline in the purchasing power and value of money, in all its myriad forms.
That is why we believe it is essential for investors to maintain a financial presence in the stock market, as one of the few financial assets that should, all other things being equal, provide real growth in income and capital. Of course, investing in real assets, such as property, should also maintain their real value over time, at the very least, but we believe the property markets, especially the buy-to-let residential property market, to be seriously overdone at the moment.
Property looks a good bet when compared to stock markets over the past couple of years, with still-reasonable rental yields available, great capital appreciation and the affordability index still showing property prices as within acceptable historical limits.
However, even though property prices have continued to soar, based on assumptions of continuing low interest rates, it should be obvious to all that the current low level of interest rates may no longer be the case for much longer.
Recent studies have even started to show that the affordability index argument may actually be misplaced, based as it is on average earnings rather than, say, the median, which is a much lower figure. Recent research now seems to point to an earnings gap between what normal people actually earn in the real world and what it costs to buy a starter home in prime property areas, even taking into account the relatively high income multiples currently available from mortgage lenders.
Bond markets also have their attractions for investors looking for income, as relatively higher yields (compared to bank and building society deposit interest rates) have combined with useful capital appreciation as interest rates have continued to fall over the last couple of years.
There are now increasing concerns about credit quality and the risk of downgradings and default in the corporate bond markets however, as a large and growing number of household names, not just limited to the telecoms sector, suffer from the burden of excessive debt in an economic downturn.
Even without these credit risks, investors must be foolhardy or brave to assume the continuance of capital gains from bonds now we are clearly at the bottom of the interest rate cycle, with rates set to begin rising again in the foreseeable future.
That is why we still believe in the equity markets as one of the only games in town when it comes to investing for income while maintaining the real value of one's capital.
But aside from recommending high income funds, which attempt to boost income above the fairly modest returns currently being paid by the stock market, either by including a portfolio of bonds to boost the fund's overall rate of return or taking on additional risk in company selection, how can investors get what they really want, while also being able to sleep at nights?
Oddly enough, when it comes to potential solutions, there are two equal but opposite trends we have been noticing in the last year or so, which are both a reflection of the markets and of investors' psychology stemming from the last couple of years' market turmoil.
On the one hand, there is a clear and growing popularity for structured products or protected funds, using a basket of derivatives to sell stock market volatility as a means of reducing risk and delivering a bond-like return. On the other, we have also seen a desire by many retail investors to return to basics, eschewing the use of fancy derivatives they cannot understand in preference for simple, easy to understand products that provide a natural income, such as rental property.
We have recently been working on a range of funds we intend to market as natural income Isas, offering a choice of one or a combination of three income-oriented Isas that can provide regular natural quarterly tax-free income from bond yields, equity dividends or a combination of both.
But what of protected funds? Although Premier has, for many years, refused to enter the structured funds market, as we remained unconvinced we could deliver a worthwhile product that combined significant downside protection with considerable upside potential and was also good value for money, we finally dipped our toe in the water a couple of months ago.
For the first time, we have been able to put together a FTSE 100-linked package that combines a relatively high level of income (either 7.5% per annum or 0.6% per month, with a 42% growth option over the five- year term) with a sensible downside floor (protecting capital against loss for market falls in the index of up to 25%). This is in addition to our lock-in feature, providing a guarantee from BNP Paribas (the largest bank in France and one of the largest in Europe) covering the hoped-for returns if the index gained 40% at any time during the investment period.
The success of this initial foray into the structured product market surprised even us: we raised £16,243,083 from 1,496 clients of 208 adviser firms, boosting our funds under management by some 3%. Indeed, we would have raised even more if we had been able to give pension fund trustees a few weeks' more time to liquidate Sipp and Sass funds for re-investment in this plan, so we know there is pent-up demand for this sort of investment product.
All things considered, we believe this type of product provides as close to a perfect balance as one can achieve between income levels, downside protection and upside participation ' meeting a large and growing need for income and safety that are now uppermost in many investors' minds.
Bond markets have been attractive for income-seeking investors, with high yields, combining with useful capital appreciation.
Property looks a good bet when compared to stock markets over the past couple of years, with reasonable rental available.
Many structured products can provide good balance between income levels, downside protection and upside participation.
‘Important to have an anchor’
Report to be written by TPR
Lack of innovation for solutions
Some 2,000 consumers affected