High Yield Investments May Carry High Risks

Many traditional defensive investments have become riskier, for instance:

• Property Trusts - Gearing has increased and they have higher international exposure.
• Bonds - The bond market index now has significant higher risk corporate debt. Plus long term yields are at low levels.
• Mortgage Trusts - The bull market in residential property has introduced some extra valuation risk into the sector and current mortgage rates are low relative to cash rates.
• Fixed Income - The market has split into instruments such as convertible notes, preference shares and collateralised debt obligations.

Look at any newspaper and you will see a multitude of advertisements promoting 'secure' yields of 9% to 10%. Many of these products are based on unsecured deposits or high-yielding debentures and are largely not covered by ratings agencies such as Moody's. However, investors seem to be happy to invest in these products as equity market performances have moderated.

This is despite the Australian Securities and Investments Commission (ASIC) having issued a warning last year about inadequate disclosure to retail investors about the risks in high-yielding debentures.

Not all investors would be aware of the risks inherent in some of these products. They should not be seen as replacement for traditional defensive products such as cash or term deposits. Higher return comes with higher risk and it is almost a certainty that a proportion of them will fail.

Are You Being Compensated For The Risk?

If a scheme has a return approaching 10% then you are almost certainly taking equity like risks. Given that most of these schemes are residential property related, a market most experts think has peaked, this may not be an appropriate investment at the present time. Also the debt is generally low ranking (debentures, mezzanine finance), and in the event of financial difficulties you are running the risk of capital loss. We would contend that currently the risk/ reward trade-offs for these products do not look attractive. This will especially be the case if interest rates increase generally either domestically or internationally.

Are There Alternatives?

We would be reluctant to chase these products simply for the high advertised yields. We think investors should be far more selective and find the best risk /reward tradeoffs. We have researched a number of well managed fixed interest products that are currently returning between 5.7% and 9% (although current performance is no guarantee of future performance). If you would like more information simply follow this link: Enquiries and mention "High Yield".

Source: Personal Wealth

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