Portfolio Analysis Basics #2 – Focus on “Yield”

Portfolio Analysis Basics #2 – Focus on “Yield”

There are classically two differing objectives when constructing a portfolio: to achieve “growth” or to achieve “income” (which is simply another word for “Yield”). These objectives do not have to be mutually exclusive; a financial adviser can (and, in my opinion, absolutely should) achieve both, with the relative degree of each objective determined by a client’s specific profile and circumstances.

In this week’s article I’m going to focus on “Yield” as another key portfolio attribute to consider, and for several important reasons.

Yield – what is it?

Yield is the annual percentage-based income that a fund produces (at least, based on previous history); creating cash for the fund holder (while the fund holder also, ideally, experiences capital growth of the value of the fund).

This income falls under different terminology depending on the type of assets (largely either “Equity / Stocks”, “Bond / Fixed Income” or “Property / Real-estate”) the fund holds:

  • Equity funds: “dividends” paid by the companies (e.g. Microsoft) held by the fund.
  • Bond funds: “interest” paid by the bodies which issued the bonds held by the fund (including governments and corporates).
  • Property funds: “distributions” paid from the rental or other property-related income generated. One example of a property-related fund is known as a REIT [Real Estate Investment Trust], and this legal structure (as an alternative to a limited company) is obliged to pay out 90% of its income to unit holders.

Great! So, do all funds provide Yield?

The short answer to that is “no”. Yield is largely generated by the funds in a portfolio which have “Bond” or “Property” assets within them.

Equity funds generally work on an “Accumulation” basis whereby the fund receives the dividends from the company shares it holds, and uses this cash to buy more shares in those companies, rather than distributing the cash to the fund holders. With Equity funds providing the majority of “capital growth” in a portfolio, it makes sense to opt for the “Accumulation” class of such funds; reinvesting the dividends to feed that growth.

The “portfolio Yield” is simply the weighted average of the fund Yields. For example, if we have a portfolio with three fund holdings (a 50% Equity fund A with a yield of 0%, a 30% Bond fund B with a yield of 2% and a 20% Property fund C with a yield of 5%) the portfolio Yield would be (0.5 x 0) + (0.30 x 2) + (0.20 x 5) = 1.6%.

Marvellous! Any downsides to Yield and/or other benefits besides income?

It’s important to remember that a high yield can be a warning sign, since it directly correlates with the risk level of an asset. The lower the credit rating on a bond, for example, the higher the risk of the bond issuer defaulting on the loan and therefore the higher the yield it will have to pay to attract investors.

That said, diversification (the principle of not putting “all of your eggs in one basket” e.g. by only investing in Equity funds) is a very good reason to invest a proportion of a portfolio in income-producing bond and property funds. These tend to be less volatile (i.e. they fall by a smaller percentage, or even rise) as stock markets fall, resulting in a smoother journey at the portfolio level for an investor.

Given that investment platforms have ongoing annual charges associated with them, it especially makes sense to generate cash within a portfolio allocation, as this can be used to partially or even wholly offset those charges.

Conclusion

Are you aware of the Yield of your portfolio? I often come across portfolios which generate a 0% Yield and for which the financial adviser may be having regular discussions with the client encouraging them to sell a portion of holdings so as to raise cash to cover charges.

Worse still, a 0% Yield portfolio may be a sign of charges having been taken Day #1 as a sub-100% allocation of the client’s money, in which case the annual conversation with the client will be to encourage them to switch funds again (generating another “Day #1” charge with sub-100% allocation).

The average Yield of one of my own typical lump sum investment portfolios, for comparison, is around 1.5%, and represents another case where, with a little attention to portfolio construction detail, you can actually have your cake and eat it.

Written by Michael Davidson
This article aims to provide information, it does not constitute financial advice, nor should it be relied upon as such. You should speak to a financial advisor regarding your circumstances before making a financial commitment. Global Financial Consultants Pte Ltd is a Licensed Financial Advisor and is regulated by the Monetary Authority of Singapore. MAS License number FA100035-3



Book Meeting
close slider

Book a meeting

Topics you would like to discuss*:
Savings & InvestmentsInsurance & Protection (Self/Family)Education PlanningRetirement PlanningCPF InvestmentUK SIPPPensionTax-Effective Strategies