Photo by Haris Hassan/The Edge
Financial services industry experts had been recommending an income-focused investing strategy long before the Covid-19 pandemic impacted global markets. They said investors would have a better chance of riding out the market volatility caused by the US-China trade tensions and other geopolitical factors by putting their money in assets that would provide them with a steady stream of passive income.
In fact, in times like these, when most financial markets are down, investors stand a good chance of buying dividend stocks at battered down prices, thus getting higher yields, assuming that the companies can continue to pay dividends despite the tough economic conditions. Meanwhile, the prices of outstanding bonds are likely to rise if interest rates continue to fall.
Personal Wealth spoke to experts on various asset classes to get their thoughts on how investors could best utilise an income-focused investing strategy in the current market environment.
Investors who want to put their money in less volatile financial instruments or those that are less correlated to risk assets can consider bonds as an alternative to holding cash, says Ganageaswaran Arumugam, a fixed income analyst at iFAST Capital Sdn Bhd. “Buying directly into bonds, be it retail or wholesale, can provide investors with liquidity in the form of fixed-rate coupons, especially in this uncertain market.”
There are benefits to investing directly in bonds rather than via bond funds, he adds. “If you compare [a bond with a fixed-rate coupon] with a bond fund that reinvests the coupons, you will see that [bond fund] investors who want liquidity will have to sell the units at their net asset value (NAV) [which determines the price of the units at that point in time].”
However, investors should be mindful that some corporate bond issuers may be struggling to deal with the economic slowdown as a result of the stringent measures taken to contain the Covid-19 outbreak. This will add pressure to their ability to service their debt.
“It becomes harder to find buyers for lower-rated paper in distressed times. So, the yields of such bonds tend to move up sharply,” says Deepak Khurana, performance director of fund ratings and distribution for Asia-Pacific at Refinitiv.
According to Refinitiv’s data, money market funds globally saw net inflows in 1Q2020 while equity, bond and mixed-asset funds saw net outflows.
At this juncture, Ganageaswaran prefers short to medium-term Malaysian Ringgit investment-grade (IG) bonds as local IG bond issuers have the balance sheet strength to absorb the current shocks to their operating income, he says. For instance, he likes MMC Corp Bhd’s bond that has a coupon rate of 5.95% and matures in 2027.
MMC is the largest port operator in the country and its key port — Pelabuhan Tanjung Pelepas — is one of the top 20 ports in the world. “It also has joint ventures that operate sizeable government-related infrastructure projects, including the Klang Valley Mass Rapid Transit Line 2 project. The strength of its operations in both port and infrastructure projects should give investors some confidence when investing in its bonds. MMC is rated AA- by Malaysian Rating Corp Bhd, which makes the paper an IG bond,” says Ganageaswaran.
According to him, the total return of the bond (price return and coupon rate) averaged between 4.69% and 5.97% from 2016 to 2019. The bond, which is offered on iFast’s Bond Express, was trading at an ask price of RM108.80 and an ask yield of 4.56% on May 21.
A wholesale bond that Ganageaswaran recommends is Matrix Concepts Holdings Bhd’s three-year sukuk with a coupon rate of 5.5%. The property developer has a lower gearing than the industry average and other notable listed property players as well as strong operating margins. “Both factors support our thesis that Matrix Concepts’ credit should hold up well despite the headwinds in the current macroeconomic environment,” he says.
The bond was issued on March 6 and will issue its first coupon in September. It was trading slightly above its par value at an ask price of RM100.750 and ask yield of 5.2% as at April 28.
Generally, in times of low interest rates, outstanding bonds are relatively more expensive. However, the recent crude oil price crash and Covid-19 outbreak triggered a selloff in Malaysian Government Securities (MGS) in March.
Since then, the government and Bank Negara Malaysia have announced a slew of measures to support the market, including cutting interest rates and launching an economic stimulus package. Consequently, MGS prices have rallied since its lowest point in March.
“While it is difficult to comment on the attractiveness of the MGS on an absolute level, the liquidity in the Malaysian capital markets and the policy measures should present a rather conducive environment for the local bond market,” says Ganageaswaran.
“The environment is likely to be conducive for the domestic bond market at least over the medium term. In addition, we believe that the fundamentals of local corporates are strong enough to weather the shock to their balance sheets and continue to fulfil their bond obligations.”
Choosing income-focused funds
The demand for income-themed multi-asset funds has led to more of these funds being launched in the country. According to the Securities Commission Malaysia, 26 of these funds, which cover fixed income, bonds, sukuk and debentures, came on the market last year to meet the demand for funds that offered dividend payouts.
Should investors switch strategies and put their money in income-themed funds at this time? It depends on the investors’ objectives and risk profile, say two industry experts. In general, they should stick to their original asset allocation strategy, which suits their preferences.
“The optimal way of investing has nothing to do with specific market conditions. According to the general principles of investing, investments are done on the risk and return expectations of investors,” says Deepak.
Based on a strategic asset allocation strategy, a relatively aggressive investor with a 60:40 allocation to equities and fixed income should keep to that ratio even though bond returns have risen, he adds. Meanwhile, a tactical asset allocation strategy calls for investors to allocate more towards equities as the recent market correction has brought down stock prices.
Phua Lee Kerk, chief strategies officer at Phillip Mutual Bhd, agrees that it depends on the investors’ objectives and risk profile. However, he hastens to add that if an investor has a short investment horizon or circumstances that require him to be more conservative, an income-focused investing strategy could be a solution.
“You could consider this strategy if your risk profile has changed or if you believe the current market situation will continue for the next 12 months or more. If you think the market will not rebound and you want a more stable performance for your portfolio, you could go for bonds or dividend funds,” says Phua.
Even then, investors have to keep in mind that companies may not pay dividends when times are bad, he adds. Real estate investment trusts (REITs) have also been impacted by the current pandemic as mall owners are expected to waive rents during the lockdown period. These factors will impact funds that invest in dividend-paying stocks and REITs.
“[For some unit trusts], investors have to be aware that income distribution is a zero-sum game. If the fund has an NAV of RM1.20 per unit and the income distribution is 20 sen, the NAV will drop back to RM1. So technically, you do not gain anything. This is different from when you buy a dividend stock,” says Phua.
A benefit of switching to an income-focused investing strategy is that the portfolio could be less volatile, he adds. But that could also mean lower returns in the future.
For those who want to adopt a more income-focused strategy, Deepak suggests that they avoid thematic funds and keep a diversified portfolio as well as look at different types of fixed-income products. “Bonds are the preferred choice for people seeking regular income,” he says.
“Bonds and money market funds have lower minimum risk. As you go higher on the yield curve, you have long and medium-duration bond funds, which have relatively higher returns and volatility. So, you could have an allocation to all these options.”
According to Morningstar’s data as at end-March, the top five funds in Malaysia with a distribution share class (where the income is distributed rather than reinvested) over the past 10 years were the Eastspring Investments Small-cap Fund, Kenanga Growth Fund, Areca equityTrust Fund, AmPan European Property Equities and Manulife Investment Asia-Pacific REIT Fund.
Opportunities in dividend stocks?
In March, many dividend stocks tumbled, presenting buying opportunities for income-focused investors. But whether they should switch to dividend stocks at this time depends on their risk profile and view of the current situation, says Areca Capital Sdn Bhd CEO Danny Wong.
“If the investors believe that the worst is not over and the recession will continue for the next one or two years, then they could adopt the income-focused strategy. But if they believe that things will be back to normal after one or two quarters of recession because of pent-up demand, then they should take the opportunity to buy at the bottom,” he says.
Since most corporate earnings will be negatively impacted due to the pandemic, should investors expect lower dividend payouts in the near future? Wong believes that will be the case for most companies. Some, like glove manufacturers, may offer windfall dividends.
But while dividend payouts may be lower, the prices of dividend-yielding stocks are also lower now. “So, the dividend yield may actually be the same as before. If you buy the dividend stocks at a lower price, then your yield could be the same as before or higher. That will compensate for the potential cut in dividend payouts,” says Wong.
In general, investors should have a mid to long-term investment horizon of more than three years, he emphasises. If the investment horizon is shorter, investors could consider adopting a more income-focused strategy.
Investors with a more pessimistic view of the market could pick dividend-yielding stocks in sectors that are least affected by the pandemic and avoid those in the aviation, hospitality and tourism industries, says Wong. Some sin stocks, like tobacco and alcohol counters, promise good yields now as their share prices have been beaten down.
Are REITs a good choice now? “I am very cautious when it comes to REITs. Investors who do not have a good view of the economy for the next few years — if they are pessimistic about a recovery in consumer spending — should avoid REITs,” says Wong.
Similarly, Vincent Lau, vice-president of research at Rakuten Trade Sdn Bhd, believes that this traditionally defensive sector will be impacted by the Movement Control Order (MCO). “Their earnings could easily be down 10% to 20%. Investors could be better off buying gaming and number forecast operator stocks. Their yields are as good and I think they will have better capital appreciation when things turn around,” he says.
“The share prices of companies such as Magnum and Berjaya Sports Toto are down because they cannot operate during the MCO. But I think once it is lifted, there will be pent-up demand. Genting could also benefit as people cannot travel overseas. So, they may just go to the theme park.”
Consumer counters and some banks are offering good yields at the moment, he adds.
Wong has more confidence in the bigger banks as the outlook for this sector is still uncertain in the near term. “My only concern now is what happens after the loan moratorium of six months. Nobody knows whether the companies or consumers can continue with their loan payments. If I were to choose a bank, it would be a stronger or bigger bank,” he says.
Lau has similar views. In a low interest rate environment, banks’ net interest margins will be negatively impacted. But as the bellwether of the economy, it is still considered a safe sector to go into.
“Companies like Maybank will not go bust. The dividend yield is now at 8%. It may drop to 6% and there could be less dividends, but the capital appreciation may come soon. Malaysia Building Society Bhd also has a good dividend yield based on the current share price, at levels almost similar to REITs,” he says.