Yield seekers should try income funds as an alternative to money market funds – BJM PCS

Risk-averse yield seekers from pensioners to conservative savers would do well to check the recent performance of income funds and compare the returns against those from increasingly popular money market funds.

The tip comes from Barnard Jacobs Mellet Private Client Services (BJM PCS), a leading, nationally represented wealth adviser with special focus on high net worth individuals.

Louis Bekker, Head of Multi-Manager Funds at BJM PCS, acknowledges the strong inflows into money market funds, but believes investors looking to protect capital at enhanced yields should consider a switch into a well-positioned income fund.

He says in a declining interest rate environment, income funds generally outperform money market funds and believes the benefit of switching from a money market to an income fund will become even more evident when interest rates are cut by another 2%. While interest rates are at the current level Income Fund’s depend on capital gains to enhance their yield over Money Market funds and to make them relatively attractive from a risk return perspective.

He concedes that “in a rising interest rate environment, as experienced locally from June 2007 to June 2008, income funds generally underperform money market funds” as they hold instruments that are more sensitive to rising interest rates. Typical instruments include listed property shares, preference shares and long-dated bonds. Since July 2008, however, income funds have significantly outperformed money market funds as rates have eased and there yield enhanced through capital gains.

“We expect Income Fund’s to continue outperforming money markets over the next couple of years,” says Bekker. “Over the next 12 months, the market expects interest rates to fall to levels not seen since 2005 – 3,5% below the current level.

“At the same time, we expect money market yields to decline to close to 8%. This is significantly less than the 10% yield to maturity on longer dated parastatal bonds, the 11% distribution yield from selected property counters and around 10% for selected preference shares.”

Bekker says income fund yields are currently higher than yields for money market instruments in the longer dated instruments, but so is capital volatility, making the monthly total return (change in capital value plus income) less predictable.

Care is essential in selecting an appropriate income fund as some local funds are more sensitive to capital volatility than others and may carry the risk of potential capital loss. Others are positioned extremely defensively.

Asset allocations indicate the extent of risk aversion. One high performing fund with a largely defensive posture holds just under 78% in cash and short-dated instruments, approximately 6% in preference shares, 2% in property and 14% in long-dated bonds.

The fund’s mission is to protect capital, with some added risk to enhance the yield over the money market, without introducing significant capital volatility.

Taking positions in a more aggressive income fund might suit some investors, but BJM PCS advises clients that in this case they should take a longer investment view; perhaps a year or more.

Bekker adds: “Although income funds come with added capital volatility risk, the benefit of locking in higher yields for a longer period is becoming more and more evident.

“Income funds are not suitable for investors with a time horizon of less than six months. Any ‘emergency money’ should be kept in a well-structured money market fund.”