IT has become increasingly well documented that the world’s financial markets have been going through a particularly turbulent time lately.
With the FTSE 100 down around 4% over the last 12 months, the current climate can hardly been seen as ideal for investment. This, combined with the price of oil rising an astonishing 85% over the last 12 months, has led to fears of a credit crunch and a global economic slowdown.
This article focuses on how investors can consolidate their investment portfolios during these uncertain times. As all uncertainty provides scope for opportunity, we believe it is possible to maintain decent investment returns during these unsettled times whilst minimising unnecessary exposure to risk. We have detailed below some ways in which this can be achieved.
Defensive choice
Investors have often been proved correct in taking comfort in the arms of dividend strategies during more unsettled market conditions. The table below shows that income approaches have historically represented a good defensive choice in falling global equity markets, with high-yielding stocks outperforming the broad market in the last two significant global equity downturns of 1989-90 and 2000-03.
Dec 1989- Aug 2000- Nov 90 March 03 Out-performance by highest income yielding global stocks 14.7% 29.7% Source: Lehman Brothers. Based on a comparison of the highest yielding quartile of stocks within the top 500 stocks of the FTSE World Index to the overall index and using local currency returns.
The superior total returns generated by highyielding stocks in extended bear markets* are partly attributable to their larger income element. In this regard, global income strategies benefit from the relative resilience of dividends versus earnings during equity market downturns. This suggests that regardless of their earnings trajectory, companies are reluctant to chop dividend payments for fear of the negative signal this sends out to the market.
Certainly, company announcements in the past couple of months suggest that many UK companies are not sacrificing dividends despite tougher trading conditions. In February this year HBOS, Barclays and Lloyds TSB shrugged off the gloom shrouding the banking sector to increase their annual dividend payments.
Why high yield?
While there is uncertainty about the short-term movement of the markets, over 85% of people recently surveyed by Hargreaves Lansdowne Asset Management Ltd were confident the stock market would be higher in three years’ time and that interest rates are destined to go down. If you follow this view, the current market volatility could present a buying opportunity.
The main issues for investors are, therefore, which areas of the stock market currently look like the best value, and how can one benefit from falling interest rates? Our view is that income, in general, provides more predictable returns than growth. Therefore, we feel that high-yielding assets provide an answer.
High-yielding shares have recently been out of favour and valuations have fallen to such a level that yields now look enticing. We believe that when confidence is eventually restored to the market, there could be a corresponding appreciation in valuations.
Corporate bonds
Also, as the credit crunch has started to hit, many financial companies have been selling corporate bonds to increase the levels of cash on their books. Historically, corporate bonds have typically yielded 0.5%-1.5% more than government bonds. This is to compensate investors for the increased risk of the investment.
With a corporate bond there is always some risk that the company will default and not honour the bond. With government-backed bonds such as gilts, there are minimal risks attached as the government will not default on the repayment of the loan.
Today, many corporate bonds are yielding greater than 2% more than gilts. This, we feel, gives us a sign that bond prices have fallen too far and provide an ideal buying opportunity.
It cannot be questioned that the current economic climate both in the UK and overseas is going through a turbulent time.
However, we feel that with the right investment strategy, investors can expect to see positive returns far in excess of the market average whilst remaining in assets that are not overly exposed to risk.
For more information on high-yielding stocks, corporate bonds or any other financial advice, contact Andrew Neale at Allchurch Bailey Investment Consultants Ltd, Almswood House, 93 High Street, Evesham, Worcs. WR11 4DU; telephone 01386 442597, e-mail invest@allchurchbailey.co.uk.
