Here at The Right Side, I’m on a mission to find you the safest ways of earning a decent return on your savings. Because the authorities have it in for you. They want to sap your wealth by making sure returns on savings run well under the rate of inflation.
Yield-hunting requires a bit of guile. You need to look where others aren’t looking. Today, I want to scope out an area that’s unfamiliar to most private investors and out of reach for most City pros.
I’ll show you an investment currently returning over 9%, paying interest quarterly.
In our quest for yield we’ve had a good old sniff around corporate bonds. It’s a sector pretty much ignored by private investors, yet there are some great returns on offer. I’m also quite partial to decent high-yield shares – dividends have been storming upwards over the last year, and it’s nice to have some exposure to that.
Now, preference shares (prefs) are a kind of hybrid of bonds and shares. Like a bond, they pay a fixed rate of interest. But like an ordinary share (ords), if things go wrong, they’re not as safe as bonds – the issuer can hold back payments if need be.
That said, prefs are a rung up from ords. If the issuer can’t pay the prefs, then there certainly won’t be any dividends on the ords. And in the event of bankruptcy, prefs stand ahead in the queue for any payouts.
But I wouldn’t get too excited about that. In the event of a liquidation, I wouldn’t expect to get a whole lot back. Prefs are still behind bonds in the pecking order. It’s the preferred dividend that makes this type of stock appealing to me. And when it comes to the pref dividends, there’s an important point to look out for...
The dividend can be cumulative, or non-cumulative. That is, if the issuer has to suspend payments, cumulative dividends accumulate, and will have to be paid out later. Non-cumulative don’t.
For instance, Lloyds has a batch of non-cumulative prefs outstanding. Because of EU rules on state aid, they’ve had to stop paying out dividends. But when payments eventually resume, holders won’t get anything for all the dividends missed. Had the prefs been cumulative, all the missed dividends would now be accumulating – they’d have to be paid out before Lloyds ever considered paying anything to ordinary shareholders.
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Do what Gordon Brown doesn’t do
During the blow-up of 2008, a whole host of banks had to go hunting for fresh capital. Even the great Goldman Sachs and Barclays International were deep in the mire. Goldman’s went cap in hand to Warren Buffett while Barclays sniffed out rich investors from the Middle East.
Now, these savvy investors weren’t going to part with their money on just any terms – they took preference shares, thank you very much. But then just look at what our government did with your money... they took ordinary shares in the likes of RBS and Lloyds. Muppets indeed!
Prefs can be traded on the stock market just like ordinary shares. The only thing is there aren’t that many of them about. What is available is often in the financial sector, and can be quite illiquid.
Now for us, the liquidity isn’t such a big issue. We’re not fund managers with hundreds of millions to place. That said, the less traded prefs can have large spreads (the difference between the buy and sell price). So if your holding period is likely to be short, then these stocks may not be for you.
But I’ve found a pref that looks interesting. Not only is it not in the financial sector, but it’s pretty liquid and has a tight bid/offer spread. Oh, and its 9% dividend is cumulative.
Income in unexpected places
Raven is a Russia-based warehouse landlord. Now, I know that anything to do with Russia will turn many readers off immediately. But Russia doesn’t frighten me. To be honest, the fact that most investors are so dismissive only increases the yields on offer for anyone with an open mind. And as I said last week, Russian political risks are exaggerated, while in the West, we’re far too complacent.
Raven Russia Cum 12% Pref Shs (Lon: RUSP) trade in London, and you can buy them through your regular broker. This morning, they’re £1.29 to buy. As the name suggests, the stock pays 12% nominal interest (ie, 12% on £1). On that basis, the stock is yielding 9.3% (12/1.29).
So, it’s got a tasty income stream. What’s more, with its cumulative dividend, it’s much safer than the ordinary shares (also traded in London).
The business has been going great guns. Profits (to Dec 2011) were up 131%, from $56m to $129m – but bear in mind, much of that was down to acquisitions. More recently, May’s interim management statement (IMS) announced that demand for its warehouses was very strong.
Vacancy rates in Moscow are around the 1% mark. Anyone who knows about the property business will know that this is a very impressive figure. What’s more yields on these properties (ie, Raven’s returns on its warehouses) are around the 12% mark – again much better than most of us are used to.
As at the year end, the company was sitting on $181m in cash!
Of course, there are risks with this sort of stock. While Russian warehousing may look good for the moment, we know that the Russian economy can turn on a six-pence. And while I’m not as concerned about political risk as most, there’s no doubt that it can’t be completely discounted.
But if you invest in the prefs, you’ll be in good company. Invesco Perpetual hold about half of the issue, and management are in for 20% too. What’s more, the ordinary shares are trading pretty well – over the last few years the shares have moved up from a 2009 low of 17p to 62p today (around its all-time high).
If you’re a bond or pref holder, it’s always worth keeping an eye on the price of the equivalent ordinary shares. If they’re doing well, then it stands to reason that anything ranking above them should be okay too.
Over the coming months, I’ll keep chasing high income plays wherever I find them. In our quest for yield (with an element of safety), we can’t leave any stone unturned.
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