INVESTING

Four alternatives to investing in low-rate term deposits

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With interest rates at historic lows, investing for income has become a challenge for many people, especially those who have retired or are close to it.

Sure, it's safe to leave your money in the bank - where deposits of up to $250,000 with each approved institution are guaranteed by the government - but your returns are unlikely to even keep pace with inflation.

"An obvious strategy for some investors has been to invest in term deposits," says Chris Andrews, chief investment officer at La Trobe Financial.

"These offer great security but very low returns. In many cases, investors are finding that the returns are inadequate to meet their needs and objectives."

term deposits etfs

The cold, hard fact is you need to take on more risk to earn better returns. But the dilemma for many investors is how much risk they can take and still sleep at night.

You can mitigate risk by diversifying, not putting all your eggs in the one basket.

"Diversification is frequently described as the 'one free lunch' in investment," says Andrews. Why? "Put simply, it allows investors to reduce their risk without reducing their return.

"This should surprise nobody. We all know the risks of putting all of our eggs in the one basket. But we're frequently surprised to hear of investors who have 'lost everything' when one (generally speculative) investment goes bad."

Don't ever be tempted to put all your money into just one investment because it's a good income payer. An example of this is popular dividend-paying shares.

"Often these dividend shares are household names and investors believe that this will give them protection against sharemarket volatility," says Andrews.

"Unfortunately, this belief is not founded in reality. Two of the best-known dividend shares are Telstra and Commonwealth Bank. At the start of 2015, Telstra was trading above $6.50 a share. At the time of writing, it was around $3.10. Shareholders have lost 50% of their capital value. Over the same time period, CBA has dropped from above $90 a share to around $73, a fall of around 20%."

CBA and the other three major banks are all still paying good dividends, with yields ranging from 6% to 6.8%, and have largely maintained their payouts.

Telstra is yielding 8.3% but last October announced a change to its dividend policy, from paying out all profits to paying out only 70% to 90% of profits this year - and that's when its share price was slammed.

Protect yourself in your quest for higher returns by diversifying not just across shares but also across asset classes. Property, selected mortgage funds and corporate debt can also produce good income.

And if choosing individual shares is not your bag, or you don't have enough funds to diversify, exchange traded funds (ETFs) and listed income companies (LICs) are good ways to go.

Here are four options for investors chasing income:

1. LICs

LICs invest in companies aiming to generate good returns for shareholders, paying out profits as fully franked dividends.

Contango Income Generator (ASX: CIE) is an example of an LIC that some analysts recommend for income-hungry investors.

"In our opinion CIE offers investors an alternative yield option to the more traditional yield players such as the banks, telecoms and real estate investment trusts," says Michael Wayne, managing director of Medallion Financial Group.

Contango invests in companies outside the 30 biggest stocks in the S&P/ASX 300.

This means it "can provide an attractive counterbalance for those portfolios that have become overexposed to ASX top 20 businesses over the years, by providing a more diversified income stream while at the same time potentially reducing the overall risk profile of the portfolio," Wayne says in an article on livewiremarkets.com in April.

He points out that Contango was trading at 96c at the time of writing, a discount to the most recently reported net tangible assets (NTA) of 97.1c at March 31, and that the income return to investors is estimated at 6.7% over a 12-month horizon before the 50% franking.

Australia's biggest LIC, WAM Capital (WAM), run by Geoff Wilson and his team, is also favoured by some analysts.

"It invests in undervalued growth companies and holds them until they reach the calculated valuation, then sells," says Tristan Harrison, a contributor to the Motley Fool investing service.

"The team have been extremely successful with this strategy as its outperformed the index over the long term. It currently has a grossed-up dividend yield of 8.78%."

Advantages

1. You can get a lot of diversification with as little as $500. 2. LICs can trade at a premium or discount to their net tangible assets (NTA), which they have to publish every month. An LIC trading at a discount can provide a good buying opportunity. 3. Because of their company structure they can retain some profits to smooth out dividends.

Disadvantages

1. If a LIC is trading at a discount this can also be an early warning sign of problems. 2. LICs are prone to the overall volatility of the stockmarket. 3. Unlike managed funds, they don't offer a regular savings program.

2. ETFs

ETFs are another way to get a big bang for your buck. While traditionally these invested in indices and were passive vehicles, more recently there has been a trend to managed ETFs, which are actively managed.

There are now about 30 of these listed on the ASX. One of the first was the Magellan Global Equities Fund (MGE), an active ETF investing in 20 to 40 of the best global stocks.

It has returned 7.81% a year since inception in March 2015 but is not a high dividend payer, with a current yield of 1.66%.

There are a group of ETFs designed for investors seeking regular income. An example is Vanguard Australian Shares High Yield (VHY), which selects stocks from the S&P/ASX 200 that are expected to produce higher dividends than the broader market.

Over the past year its price has fallen 6.87% but its dividend yield is 7.3%. ETFs concentrating on fixed income are also increasing. An example is the SPDR S&P/ASX Australian Bond fund (BOND), which invests mainly in treasury and government bonds. Its dividend yield is 3.34%.

Advantages

1. ETFs offer heaps of diversification and choice for low cost as they generally invest in a diversified portfolio, which can be difficult for retail investors to access or replicate. 2. You don't have to complete any forms or additional paperwork, as you do with traditional managed funds. 3. Active ETFs are more transparent than traditional managed funds, as they provide intra-day pricing via the stock exchange. 4. Likely to trade at or near their NTA.

Disadvantages

1. You pay brokerage every time you buy or sell an ETF. 2. They suffer from volatility. The potential for large swings will mainly depend on the scope of the fund - one that tracks a broad index is less likely to be as volatile as one that tracks a specific industry or sector. 3. Smaller ETFs can lack liquidity because they're thinly traded.

3. Corporate bonds

A recent report from fixed-income specialist FIIG Securities and Deloitte Access Economics found growing awareness among investors of the potential of corporate bonds to diversify their portfolio while receiving strong returns and a steady income.

The Corporate Bond Report 2018 found the Australian corporate bond market has grown by more than 40% since 2010, and with more than $1 trillion of Australian corporate bonds outstanding it is more than two-thirds the size of the Australian stockmarket.

The report outlines that the average gross return of corporate bonds was 6.1% in the 10 years to 2016, outperforming the Australian (4.3%) and global sharemarkets (5.5%).

Corporate bonds offer predictable income, capital stability, diversification and the potential to earn better returns. You can invest through a fund or direct.

One way to go direct is to invest in XTBs (exchange traded bonds), which are traded on the ASX through many brokers and have no minimum investment. They offer access to the performance and benefits of corporate bonds combined with the transparency and liquidity of the ASX.

Examples include YTMQF2, issued by Qantas and maturing in June 2021 with a yield to maturity of 2.971% and paying a running yield of 6.447%, and YTMGPT, issued by GPT, maturing in January 2019 with a yield to maturity of 1.287% and paying a running yield of 6.38%. (See xtbs.com.au.)

There are many managed funds investing in both corporate and government bonds and listed vehicles, including ETFs and mFunds.

Master Income Trust (MXT), which listed in October, invests in corporate debt and targets a return of the Reserve Bank cash rate plus 3.25%pa net of fees (currently the return is 4.75%) and pays cash distributions monthly.

Advantages

1. Corporate bonds are generally less risky than shares issued by the same company and bond holders generally rank higher than shareholders if the company fails. 2. Corporate bonds can offer a stream of coupon payments and the return of the principal on maturity. Alternatively, the payment of share dividends is at the discretion of the company. 3. You can design a relatively stable income stream from corporate bonds by investing in bonds from different companies that have different maturity dates. 4. Corporate bond prices are usually less volatile than shares for the same company.

Disadvantages

1. Corporate bonds are unlikely to give you capital growth. 2. If you decide to sell your bond on a secondary market before maturity you may get a lower price than the face value. 3. There may also be fewer potential buyers for the bond, which can be a problem if you need your money back quickly.

4. Mortgage funds

These funds had a tough time in the GFC, and many never really recovered. Researcher Morningstar lists 15 open mortgage funds (see morningstar.com.au for details), including Trilogy Monthly Income Trust, which has paid 7.98% a year for three years.

The minimum investment is $10,000.

The La Trobe 12-month Term Account (formerly the Pooled Mortgages Fund) ranks third in three-year performance in Morningstar's listing, paying 5.35% a year. The minimum investment is $10, making it very accessible.

This fund has stood the test of time, wining Money's Best Mortgage Fund title in the annual Best of the Best awards nine years in a row (December-January edition). It's one of four investment options offered by specialist mortgage manager La Trobe, with returns ranging from 3.8% to 7%.

"We offer many levels of diversification to our investors to help them manage their investment risk," says Andrews. "We've succeeded where others have failed because of several factors."

Established in 1952, La Trobe is an asset class specialist. "We have 300 staff who live and breathe mortgages," says Andrews.

"We get the assets right, we steer clear of loans that have got others into trouble, such as land banking and large projects. We have built a granular portfolio of $1.2 billion with an average loan of $424,000.

"We also get our investment strategy right. If we know investors are there for 12 months we have certainty of money and we can deploy."

And La Trobe's credit policy is "industrial strength" and based on the "five Cs" says Andrews. These are: Character - borrowers employment and residential history, any past issues. Capacity - ability of borrower to service the loan without undue hardship. Collateral - loan to value ratios are a maximum of 75% and averaged 62.4% at end of March. Capital - "We like our borrowers to have skin in the game," Andrews says. Conditions - "We can impose myriad conditions to ensure investors are protected," says Andrews.

Advantages

1. Mortgage funds target capital stable, income-based returns from portfolios of loans secured by mortgages, one of Australia's largest and best performing asset classes. 2. Regular income payments. 3. Capital stable returns.

Disadvantages

1. Be wary of funds that allow related-party transactions. 2. Avoid those with high loan-to-value ratios and lack of diversity of loans. 3. The manager's experience is crucial. M

This report was sponsored by La Trobe but was independently researched and written

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Money's founding editor Pam Walkley stepped down in early 2015 after more than 15 years at the helm. Before that she was at the Australian Financial Review for 11 years, holding several key roles including news editor, chief of staff and property editor. Pam is now a senior writer for Money.
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