As returns on cash collapse, bond yields plunge and companies suspend their dividends, generating income from your portfolio has got harder than ever.
The “search for yield” became intensified when interest rates plunged after the financial crisis, but today the challenge is greater than ever.
As central bankers battle to salvage the global economy, interest rates and bond yields are set to remain "very low, for a very long time”, says Masroor Batin, chief executive of BNP Paribas Wealth Management, Middle East and Africa.
Do not despair, you can still generate a decent yield if you know where to look, he says: “We are encouraging clients to build a diversified portfolio including quality corporate bonds, hedge funds and structured products. Emerging market bonds in local currencies bring further diversification and valuations are low.”
You can still secure yields of between 3 and 6 per cent. The more risks you are willing to take with your capital, the higher the potential income.
Zainab Kufaishi, head of Middle East and Africa at fund manager Invesco, says cautious investors should focus on lower-risk bonds, such as government bonds and “investment-grade" corporate bonds issued by companies with healthy balance sheets and lower likelihood of default.
She says more adventurous investors are looking to generate higher returns by investing in emerging market bonds and high yield bonds. “Emerging market bond markets are now more developed and easier to access. Awareness is growing and they offer an attractive option for portfolio diversification,” she adds.
Vijay Valecha, chief investment officer at Century Financial in Dubai, recommends reducing risk by investing in a range of bonds at minimal cost, using a low-cost exchange traded fund (ETF).
Mr Valecha recommends a number of investment-grade corporate bond ETFs with solid but unspectacular yields, notably iShares Broad USD Investment Grade Corporate Bond ETF (USG), which yields 3.16 per cent.
He also tips iShares Intermediate-Term Corporate Bond ETF (IGIB), which yields 3.19 per cent, and iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD), with income of around 3 per cent.
Russ Mould, investment director at wealth platform AJ Bell, says high-yield corporate bond funds give you more income, but with added risk: “Issuing firms have weaker balance sheets and therefore have to offer a juicy coupon to attract investors.”
He favours Baillie Gifford High Yield Bond, which yields 4.4 per cent from a portfolio of sub-investment-grade corporate bonds.
Emerging market bonds are also riskier but potentially more rewarding and he recommends M&G Emerging Market Bond fund, which yields 6.6 per cent from government and corporate bonds issued in Russia, Brazil, Mexico and other countries.
Mr Valecha tips emerging market bond fund VanEck Vectors JP Morgan EM Local Currency Bond ETF (EMLC). “This yields 6.29 per cent from government bonds denominated in local currencies.”
He also suggests municipal bonds, which are issued by state and local governments to finance public projects such as roads, schools, airports and infrastructure. US-based bond fund Guggenheim Taxable Municipal Managed Duration Trust (GBAB) currently yields a meaty 6.58 per cent. BlackRock Taxable Municipal Bond Trust (BBN) yields 5.39 per cent and VanEck Vectors High-Yield Municipal Index ETF (HYD) yields 4.41 per cent.
Mr Valecha says despite stock market volatility, now is a good time to buy shares as economies start reopening. “Even if we get a second wave of infections, governments are unlikely to reimpose lockdowns as they seek to balance both the human and economic costs,” he adds.
High street and shopping retailers have been hit hard by the movement restrictions, but he tips mall operator Simon Property Group, the largest in the US, which currently yields 12.82 per cent.
It now seems likely the dividend will be cut, possibly by half, but this would still leave a generous level of income. Mr Valecha says SPG retains a strong balance sheet and has increased its core earnings margin in nine of the past 10 years. “This is a testament to the strength of its portfolio of malls and premium outlets, which should help it to recover faster,” he says.
Computer giant IBM, actually raised its dividend during the pandemic, its 25th consecutive increase, says Mr Valecha and now "yields 5.6 per cent and is positioning itself for strong growth in cloud and AI technologies".
Healthcare is an attractive sector in a pandemic and UK pharmaceutical giant GlaxoSmithKline boasts a solid dividend track record, now yielding 4.89 per cent. “It has a strong pipeline of drugs in oncology and HIV and spinning off its consumer health division should generate extra value," says Mr Valecha.
He also rates US biopharmaceutical corporation Pfizer, which outperformed the S&P 500 index during the pandemic and yields 4.53 per cent.
US telecommunications giant Verizon held up well during the financial crisis in 2008, and is doing so again, Mr Valecha says. “Its strong brand, low valuation, high yield, and robust cash flow growth all make it a great defensive play in a difficult market. It has hiked its dividend annually for 13 straight years and now yields 4.54 per cent.”
Russ Mould, investment director at wealth platform AJ Bell, advises investors to look for companies with a track record of regularly increasing shareholder payouts. “That gives you capital growth as well as income, as a rising dividend will usually drag the share price along for the ride.”
The UK remains an attractive source of dividend income, even though almost half the companies on the FTSE 100 have cancelled or suspended their payouts during this year’s crisis.
Water company Severn Trent has bucked the trend and should yield around 4.5 per cent. This is a defensive stock, as the company has won regulatory clearance for its pricing all the way to 2025.
Mr Mould also tips Telecom Plus, which supplies gas, electricity, landline, broadband and mobile services to homes and businesses, and yields 3.8 per cent. “It has minimal debt, is coping well with the pandemic, and should benefit as rivals fold,” he says.
Alternatively, spread your risk with iShares Core FTSE 100 ETF, which should still yield 3.6 per cent this year, he adds. "The downside is that just 20 stocks now pay three quarters of total dividends, and there could be more cuts."
He also suggests looking beyond the UK, to Europe and Asia. Yields may be lower, but this gives you diversification.
Swiss pharmaceuticals and diagnostics giant Roche is set to yield 2.5 per cent. “It is one of only a handful of firms to have received American regulatory approval for its Covid-19 antibody test,” he says,
Mr Mould names Zurich-listed food producer Nestle, which yields 2.5 per cent, German real estate firm Vonovia (3 per cent) and French pharmaceutical group Sanofi (3.4 per cent).
In Asia, tech firms Samsung Electronics and TSMC yield 2.9 per cent and 3.4 per cent respectively. “They have powerful market positions and will benefit if the global economy recovers in the second half of this year.”
Mr Mould also recommends US healthcare firm Johnson & Johnson, which has increased its dividend every year for more than five decades, and currently yields 2.8 per cent.
Other income options
Dr Ryan Lemand, senior executive officer of ADS Investment Solutions (ADSI), says the stock market rebound has left both stocks and bonds “richly valued”, and investors should be wary.
Bond prices may fall while global stock markets have been artificially inflated by expansionary monetary policy, which "leaves a huge disconnect between equity valuations and the real global economy".
He advises clients to invest in Sharia-compliant investment products, that "by design do not use leverage, which reduces risk".
Some clients are keen to take advantage of today's near-zero interest rates to invest in real estate, which can generate yield from rentals.
There are opportunities if you look. “Luxury properties, for example in Paris, have actually increased in value,” he says.
Mr Lemand warns against investing in commercial property funds. “Office rents and values are likely to fall as companies downsize and cut costs, while working remotely may become common practice.”