Looking forward to where to invest in 2009, the key word is going to be “value”.
All savvy investors know that you need to buy well to make money: selling at the right time is less important.
So why is the word value so significant? Historically, to value an asset, one took the income receivable or “yield” and capitalised this with an income multiple to arrive at the capital value. Effectively, ask the question: “What capital sum would you be prepared to pay for the right to receive the income stream?”
This method of calculating value has been totally discarded and has caused many of the recent problems of over inflated asset values. We should return to this basic principle and remember it always as it is a golden rule for investors.
Let’s look at some examples which may help us decide where to invest in the coming year.
The income yield on property is derived from rental. Residential property is usually let on a six month assured tenancy basis, giving rise to the possibility of vacant periods with no rent and downward rental values if there is a surplus of property over tenants.
The yield on many residential properties has fallen to only three per cent, ie £500 per month (£6,000 per annum) on a property valued at £200,000.
Given a long term trend of yield at six-seven per cent, to adjust either the rent has to double (tenant leaves and rents elsewhere or buys) or the value has to fall to £120,000.
The latter is what has happened. In the commercial property sector yield is again derived from rental, but leases are more secure, usually a minimum of five years and rent reviews are often upwards only.
As tenants are less likely to move premises because of the cost, the only likely scenario for a landlord to lose rental income is if the tenant goes bust, which is what we are seeing in this recession, especially in the retail sector.
The yield on Government Gilts has fallen to only two per cent as investors have sought the safety of lending money to the Treasury. There appears little further interest in traditional gilts, especially as so many more will have to be issued next year to pay for the government’s spending plans.#
Corporate bonds however have far more upside, although the risk of default is greater. The income yield is the interest paid by the company for you lending money to them.
The income receivable for investors is the dividend payable, usually half-yearly and the ability of a company to pay is based on profits and reserves in its accounts.
The yield on the FTSE 100 index has risen to 4.5 per cent as share prices have fallen, offering value compared to a long term trend of around three per cent.
Sound companies with profits unaffected by the recession, allowing the dividend to be well secured, will be much sought after.
So, looking forward from here into 2009, what strategy to employ? The Royal Institution of Chartered Surveyors (RICS) expects property to fall further yet, so maybe this is something to look at in the second half of 2009.
Investment grade (lower risk) corporate bonds certainly seem to offer good value compared with market interest rates.
Equity Income funds search out high yielding shares, particularly in defensive sectors, and the Invesco Perpetual Income and High Income funds may represent good value.
Perhaps feed money in monthly over the next 12 months to ease the risk of timing. An asset with a secure income stream yielding over five per cent per annum should represent good value.
* Trevor Law is a director with Montpelier Group (Europe) Ltd, the privately-owned independent financial advisers located at Barston near Solihull. E mail: TILaw@montpeliergroup.com