UAE investors and the hunt for dwindling yield
The collapse in global interest rates has been a disaster for UAE expats looking to generate income from their investments.
Record low rates have savaged the returns on cash, with savers now lucky to get 1 or 2 per cent a year from an offshore bank or UAE-based account.
It has also hammered returns across a range of financial products, including bonds and annuities, and triggered a worldwide “search for yield”, as investors hunt around for higher levels of income.
Daniel Williams, the chartered investment director at wealth managers Arbuthnot Latham & Co in Dubai, says too many investors still have inflated expectations of the kind of return they can get, looking for 10 to 12 per cent a year. “Slowly, however, expectations are beginning to fall. People need to understand the risks involved in seeking even 5 or 6 per cent a year.”
He adds: “You can get 7.75 per cent a year by investing in a 10-year government bond issued by Greece, but would you want to do that?”
So far property has stood tall as the best option, but prices may have peaked in many major markets, meaning now is a risky entry point.
Income-generating investments are particularly useful if you are retired looking to top up your pension, but this isn’t their only benefit.
Any asset that generates a regular income is valuable, and if you don’t need the money today you can put it to work by reinvesting it to build your wealth tomorrow.
So where can you find income these days - cash, bonds, equities or property?
Cash is king was once a popular saying, but that was a long time ago. Even if you park a princely sum in a savings account, you will only get a pauper’s return.
You can get a slightly better return by shopping around, with UAE comparison sites such as Souqalmal.com, Compareit4me.com and Moneycamel.com handy ways of checking what’s out there.
Souqalmal.com, for example, currently shows the UAE-based HSBC Savings Account paying just 0.1 per cent on a minimum balance of Dh3,000.
The United Arab Bank (UAB) Ultra Savings Account pays a more competitive 2 per cent, also on Dh3,000 and above.
Don’t just go for the highest rate, check that the account’s features work for you. For example, the UAB account can only be opened in dirhams, whereas HSBC also accepts US dollars, sterling and renminbi.
There is little respite offshore, where savings rates are also low. Nationwide International’s Bonus Access Account Issue 8 pays a variable 1.05 per cent on £25,000 and above, but this is inflated by a 0.55 per cent bonus that expires after the first year.
NatWest Offshore Instant Saver pays 0.75 per cent, but only if you park £50,000 (Dh269,000) in the account.
Given that inflation in the UAE stood at 4.1 per cent last year, the value of your money is being eroded in real terms.
Ashley Owen, head of investment strategies at AES International, says that savers who don’t want to take any risks with their money must accept today’s low returns. “With interest rates falling to record lows, expectation for yield should be tapered.”
Returns will improve when global interest rates start rising, but that seems unlikely with the US Federal Reserve now backing away from further rate hikes. In the euro zone, Switzerland and Japan, interest rates are negative. And so is the outlook for savers.
Bonds have traditionally been the next step for those wanting a slightly better return than they can get on cash, but without too much risk.
You can invest in government bonds or corporate bonds, which companies issue to fund their expansion.
Few private investors will directly buy bonds, most prefer a mutual fund offering a blend of government and corporate bonds. These give you a combination of income, and capital growth if bond prices rise.
Ashley Owen says returns on government bonds have slumped. “Five-year US Treasuries currently yield just 1.38 per cent a year. This is a low return although your investment is safe because it is backed by the US government.”
Earlier this year, it emerged that more than $7 trillion of government bonds offered yields below zero, making up almost a third of the Bloomberg Global Developed Sovereign Bond Index. This means you actually pay the issuing government to hold their bonds.
Around half of all European government bonds have sub-zero yields, including Germany, France, Italy, Spain, Switzerland, as well as Japan. Don’t despair, you can still generate some income and growth from bonds.
Mr Owen suggests popular mutual bond fund M&G Optimal Income, which invests in a spread of government and corporate bonds from the United States, United Kingdom, Germany, France and elsewhere, and currently yields 2.95 per cent a year, with an annual charge of 1 per cent (see box 1).
The fund’s total return from income and capital growth over five years is 34 per cent, according to figures from Trustnet.com.
Mr Owen also tips Kames High Yield Bond, which invests in high-yield bonds in the US, UK, Luxembourg, France, Canada, Switzerland and Germany, and currently yields 4.97 per cent. Total return over five years is 26 per cent and the charge is a competitive 0.75 per cent.
Some funds combine bonds with stocks and shares to produce a higher potential return, although with more risk.
Schroder Global Multi Asset Income invests in a vast spread of global bonds mixed with some stocks and shares, and currently yields 2.45 per cent.
Jupiter Monthly Income is 85 per cent invested in equities and 15 per cent in bonds and cash, and currently yields 4.90 per cent. This fund is unique as it distributes dividends monthly.
Mr Owen says that the “hunt for yield” can be risky. “You must look at the history of your chosen asset class to see how it has performed.”
Bonds, which pay a regular income with a pledge to return your capital at the end of a set term, are not completely risk-free.
The danger is that the issuing company (or government) runs into financial difficulties and defaults, and you lose your money.
Mr Owen says the higher the yield, the greater the risk. “High-yield bonds are sometimes known as junk bonds. They have a higher default rate, and some can be as volatile as stocks and shares.”
One investment mantra that consistently holds true is this: the higher the potential return, the greater the risk.
Stocks and shares can generate higher income and capital growth in both cash and bonds, but are more volatile in the short term. In the longer run, however, you can expect them to beat both.
Tom Anderson, regulated investment adviser at the financial advisory company Killik & Co in Dubai, says that even in today’s uncertain markets you should still hold equities, provided you intend to keep your money invested for a minimum five or 10 years, preferably longer.
“Bond yields are now so low that investors may have to take more risks by investing in stocks and shares,” he says.
He says income seekers should look for a mutual fund that invests in large, dividend-paying stocks. “You might consider Fidelity Global Dividend, which invests in major companies such as Johnson & Johnson, British American Tobacco, Procter & Gamble and General Electric.”
The fund currently yields 2.89 per, cent but the attraction of stocks and shares is that successful companies aim to raise their dividends year after year, which means your income increases over time. The charge is a competitive 0.75 per cent.
Mr Anderson also tips CF Woodford Equity Income, launched two years ago by the hugely popular UK fund manager Neil Woodford. His investment record is superlative: if you had made a £10,000 investment in his previous fund, Invesco-Perpetual Income, at launch your money would have grown to £140,000 20 years later.
“The UK is always a place to find dividend-paying stocks, but 20 per cent of Woodford’s fund also contains overseas companies,” says Mr Anderson. It currently yields 3.58 per cent with an annual fee of 0.75 per cent.”
You can get even lower fees by investing in exchange traded funds (ETFs), which passively track a defined basket of stocks, he says. “SPDR Global Dividend Aristocrats invests in companies that have paid stable or growing dividends for at least 10 years. It yields 4 per cent with ongoing charges of about 0.5 per cent.”
Alternatively, experienced investors could build a portfolio of individual company stocks, thus avoiding fund manager charges.
Some companies offer highly attractive yields at the moment, but dividends are not guaranteed and many have been cut lately.
“Oil majors BP and Royal Dutch Shell currently yield 7.63 per cent and 7.57 per cent, respectively, while mining giant Rio Tinto yields 7.27 per cent,” says Mr Andersen. “Be warned, their share prices have been very volatile lately due to sharp swings in oil and commodity prices, and there is a danger their dividends could be cut in future.”
This is a gamble, but as the oil price climbs above $50 a barrel, it could be a punt worth taking.
Healthcare stocks are thought to be lower risk with GlaxoSmithKline and AstraZeneca paying out 5.52 per cent and 4.67 per cent, respectively, although remember these are not guaranteed.
Mr Williams of Arbuthnot Latham & Co says you may generate high yields from specialist investments such as emerging market debt or dividend-paying European stocks, although you should take specialist financial advice first.
Absolute return is another area to consider. Mutual funds targeting this area aim to generate a positive return regardless of what happens to stock markets.
Successful funds include CF Odey Absolute Return, which returned 32 per cent over the past three years; JPL Global Macro Opportunities, which grew 28 per cent; and Henderson European Absolute Return, up 21 per cent, according to figures from Trustnet.com.
Property has been the most eye-catching investments over the past two decades, with prices driven ever higher by low interest rates and growing demand from global investors seeking a home for their money.
Investors can get a mix of capital growth and rising prices and income if they rent it out to tenants.
Price growth is slowing globally, new figures suggest, although certain markets remain red hot.
Prices in Vancouver, Canada, for example, have leapt 25 per cent over the last year, according to the latest prime global cities index from Knight Frank. Shanghai, Sydney and Melbourne also grew by double digits.
Yet the figures also showed overall global price growth slowing to just 3.6 per cent while governments in Canada, Australia, China, the UK and elsewhere are slapping new taxes on overseas investors in a bid to curb demand and prevent bubbles. Tokyo, Milan, Kuala Lumpur, Paris, Moscow, Hong Kong and Taipei all suffered house price drops over the past year.
Kate Everett-Allen, a partner at Knight Frank in residential research, says that former hotspot prime central London grew just 0.8 per cent, its worst performance since the financial crisis, as new taxes bite. “As of April 1, buy-to-let investors and second-home buyers pay an extra 3 per cent stamp duty on any UK purchase, which may hit demand,” she says.
Higher prices mean lower yields, so avoid overpaying, while future interest rate hikes will also hit your returns.
Price growth in Dubai has been flat lately but yields of more than 5 to 7 per cent are still possible.
Faisal Durrani, the head of research at Cluttons, says: “Dubai’s fortunes are intrinsically linked to the global economy, and it is slowing in line with global growth.”
He adds: “However, it may be boosted by fresh demand from Iran now that sanctions and restrictions on overseas investments have been lifted.”
If the US Federal Reserve continues to increase interest rates then rates in the UAE are also likely to rise, pushing up investor costs and reducing profits, Mr Durrani warns.
And Mr Owen at AES warns that property is an “illiquid” investment, which means that unlike cash, bonds or shares, you cannot sell up and get your money in a hurry. “You also have to allow for maintenance costs and transaction charges such as legal and surveyors fees, which will also erode your total return.”
The glory days for property investing may be over, at least for now.
Beware of investment charges
When choosing a mutual fund you must look closely at the underlying charges, as these will eat into your income.
Tom Anderson at Killik says that a fund yielding, say, 3.5 per cent but charging 1.5 per cent is only really giving you to 2 per cent a year.
“As a rule, the annual management fee should be below one per cent, ideally 0.75 per cent,” he says.
You also have to beware of other charges, such as upfront fund charges, which can top 5 per cent, even though a growing number of funds charge nothing at all. Mr Anderson says: “You should never pay more than 1.5 per cent up front.”
UAE investors should aim to buy mutual funds directly rather than through an offshore insurance bond, which adds another layer of costs, he says.
If buying through an adviser, you should also question how much they are charging, as this adds another layer of fees.
“Avoid funds that pay trail commission to the salesperson, which again, comes out of your return,” Mr Anderson adds.