James R Rieger of S&P Indices looks at how investors can create income within their portfolios, and explains issues and considerations to bear in mind around yield and also inflation.

Date: Feb 2012

Tags: Income, Yield, Inflation, Portfolio construction

• Investors looking for income can buy high dividend-paying equities, or look at opportunities in fixed income instruments
• What drives yield is not only the ability of the borrower to repay its debt – it is also the structure of the loan itself
• The main consideration with yield-enhancing products and strategies is risk
• When looking at fixed income, particularly bonds, which make a set repayment over time, inflation is also an important driver of a decision about whether to invest

According to James Rieger in an interview, investors which are looking for income have a number of ways of doing so.

For example, he explained, there are high dividend-paying equities, which can be an important part of an investment portfolio. Plus, there are opportunities in fixed income instruments to earn a steady stream of income for a portfolio.

Within the fixed income space, however, each type of bond has different liquidity, credit quality, structural and cash flow characteristics, said Rieger.

Drivers of yield

Given that yield is a comparable measure, when comparing one bond to another, Rieger said investors can view yield as a measure of risk.

But what drives yield is not only the ability of the borrower to repay its debt – it is also the structure of the loan itself, he explained. In Asian markets, the term can be quite short relative to the global bond markets.

There are also different types of ways to measure yield, he added, explaining that one of the commonly-used ways is yield-to-maturity, which assumes investors hold the bond until it matures.

Factors affecting yield

According to Rieger, market perceptions on the ability of the borrower to repay the loan based on the provisions in the contract is one of the factors affecting yield.

Others, he added, include supply and demand, as well as the relative attractiveness of other bonds in the market.

Considerations with income products

The main consideration with yield-enhancing products and strategies is risk, warned Rieger.

In the bond markets, the first risk relates to the potential for default, meaning whether the investor will get repaid. Another risk is liquidity risk, relating to whether an investor can sell the bond for what they think it is worth. Further, interest rate risk refers to where the rate will be in six or 12 months, for example, and how that will impact the bond portfolio.

Impact of inflation

When looking at fixed income, particularly bonds, which make a set repayment over time, Rieger said that inflation is an important driver of a decision about whether to invest.

In particular, said Rieger, there are vehicles in the fixed income market which help investors off-set perceived changes in inflation.