Updated: 29/09/2015
Whilst investors continue to seek new ways to generate a predictable and regular income stream from their capital, it is perhaps understandable why the combination of a high level of fixed income and regular payments, along with some capital protection against a falling stock market, have become so popular. With last year’s significant increase to the ISA allowance these have also been popular with ISA investors. We therefore compare two of our best selling income investments to help understand what is driving their popularity and why they might meet your income needs.
An all too familiar picture
Despite the recent hints by the governor of the Bank of England, Mark Carney, that we may well see an interest rate rise by the end of the year, both savers and investors will not be fooled about any short term impact this could have as they continue to face the harsh reality of record low interest rates and historically low savings rates. And perhaps those who have suffered more than most are those seeking income from their capital.
Fixed income proving popular
Against this difficult economic landscape, not only have fixed income investments been one of the real success stories in recent years, but this interest continues to rise as the needs and demands put on more of us from our capital fails to be met by traditional products, which often have variable and less predictable income. By combining a high fixed income with some capital protection conditional on the performance of the stock market, these plans offer a compelling balance of risk versus reward that is not commonly available elsewhere in the world of retail investments.
Head to head
Here we compare two of our most popular fixed income investments currently on offer, both of which offer a high level of fixed income. The Enhanced Income Plan from Investec offers 5.40% fixed income, whilst the 4 Year FTSE 4 Monthly Income Plan from Meteor offers a higher fixed income at 7.32% each year. Both plans put your capital at risk, the Investec plan if the FTSE 100 Index falls by more than 50% and the Meteor plan should any one of four FTSE 100 listed shares fall by more than 50%. This is known as conditional capital protection and is one of the plans’ main differentiators when compared to other types of high yield investments such as investment funds.
Fixed income
Another major difference between these plans and other types of income investments is that both pay a fixed income. This means that you receive your income regardless of the performance of the stock market, so the investor has the certainty of knowing at the outset exactly how much he will receive each and every year. Investment funds on the other hand usually offer a variable income based on the performance of the underlying investment, and so can up and down over time.
Monthly income
Another important feature of income investments is how often income is paid out. The most common payment frequencies are bi-annually, quarterly and monthly with the more regular frequencies usually being the most popular, especially for those looking to supplement existing income or to boost retirement income from their capital.
Both investments pay income monthly, which can often be the most useful in terms of budgeting and is attractive when looking to supplement existing income or boost retirement income from your capital. Investec offers a monthly income of 0.45% (equivalent to 5.40% per year) whilst Meteor’s plan pays 0.61% each month, equivalent to 7.32% per year.
Fixed term
Both plans have a fixed term, six years for the Enhanced Income Plan whilst Meteor’s plan has a shorter term of four years. Although you do have the option to withdraw your money early (and in this respect is not dissimilar to investment funds), both investments are designed to be held for the full term and early withdrawal could result in you getting back less than you originally invested. Equally, it could involve you receiving more depending on market conditions at the time.
The fixed term may appeal to those who wish to plan around this and combined with a fixed monthly income, provides investors with a clear picture of exactly how much will be paid, when, and for how long. In the current economic and investment climate, either plan could be seen as a viable option.
Conditional capital protection
When considering any investment it is important to understand the balance of risk v reward. Inevitably, the opportunity to receive higher fixed returns than might be available from cash deposits, requires the investor to put their capital at risk.
Another feature of these two investments is what is known as conditional capital protection. This means that the return of your initial investment is conditional on the performance of the underlying investment. For the Investec plan, this is based on the performance of the FTSE 100 Index and provided the FTSE does not fall by more than 50% of its starting value throughout the investment term, investors will receive a full return of their original investment. However, if it does fall below 50%, and also finishes lower than its value at the start of the plan, your initial investment will be reduced by 1% for every 1% fall.
As a trade of for the higher level of fixed income on offer from the Meteor FTSE 4 Monthly Income Plan, the return of investor’s capital is based on the performance of four shares listed on the FTSE 100 Index, rather than the Index itself. If the value of the lowest performing share is less than 50% of its value at the start of the plan, your initial capital will be reduced by 1% for each 1% fall. This is measured on the final day of the investment only.
With both investments you could therefore lose some or all of your initial investment.
Since both investments pay income regardless of the performance of the stock market, the risk to your capital in each is one of the main differences between the two plans.
Risk versus reward
The principle of risk v reward means that the search for potentially higher returns leads to the need to put your capital at risk. A good benchmark for assessing your investment is to compare what you could get from a fixed rate deposit over a similar timeframe and then consider whether you are comfortable with the risk to capital you are taking in order to receive a higher fixed return.
Leading five year fixed rates are currently offering a little over 3.0% and so by accepting risk to your capital, the Investec plan increases your fixed return by around 2.4% a year while the Meteor plan offers around 4.3% more fixed income each year. With the market failing to meet the need for higher levels of fixed income the decision is whether you are comfortable with putting your capital at risk and the conditional capital protection offered in return for the higher fixed returns on offer.
Credit ratings and agencies
Unlike a fund, your investment is used to purchase securities issued by Investec Bank plc and Commerzbank AG (Meteor plan) and therefore, their ability to meet financial obligations becomes an important consideration. This is known as credit risk and means that in the event of either company going into liquidation, you could lose any future returns as well as some or all of your initial investment and these investments are not covered by the Financial Services Compensation Scheme for default alone.
One accepted method of determining credit worthiness of a company is to look at credit ratings that are issued and regularly reviewed by independent companies known as ratings agencies. Fitch is a leading credit agency and as at 19th June 2015, Investec has a BBB- rating with a stable outlook while Commerzbank AG has a BBB rating with a positive outlook. The ‘BBB’ rating signifies both institutions are considered medium grade and as such may possess certain speculative characteristics whilst the ‘-‘ denotes Investec is at the lower end of this particular rating grade. A stable outlook indicates the rating is not likely to change in the short to medium term (around 6 months to 2 years) whilst the positive outlook indicates it could change over this same timeframe.
Global profiles
Investec is an international specialist bank and asset manager with its main operations in the UK and South Africa. Established in 1974, as at April 2015 they look after £124.1 billion of customer assets as well as a further £22.6 billion of customer deposits and employ around 8,250 people. They specialise in a number of areas, particularly within the banking sector and are a leading provider of investment plans and structured deposits in the UK.
Commerzbank AG is the second largest high street bank in Germany with nearly 15 million individual customers and 1 million business and corporate clients. The bank opened its first branch in London in 1973 and in 2013 generated global revenues of approximately €10 billion with approximately 54,000 employees. Commerzbank AG is active in the structured investments and has over 170,000 investment products for retail, institutional and private investors currently in issue.
Fair Investment conclusion
The market for income investments is full of attractive yields but it is important to fully understand how each investment works and the risks it entails. Whether this is inflation risk, risk of capital loss or fluctuating yields, it should always be remembered that it is the income and capital loss/rise combined that produce your overall return.
Commenting on the two investments, head of savings and investments at Fair Investment Company Oliver Roylance-Smith said: “By combing a high level of fixed income, monthly payments and a return of capital unless the FSTE falls by more than 50%, Investec’s Enhanced Income Plan offers a compelling balance of risk versus reward and is one of our most popular income investments that could be considered by investors and savers prepared to accept risk to their capital”.
He continued: “By comparison, the four year term and significantly greater monthly yield from Meteor’s offering, along with the marginally stronger counterparty credit rating, may well appeal to those in search of a high level of fixed and regular income. However, the fact that the return of your initial capital is based on the performance of four shares rather than the Index as a whole does make this a higher risk investment.”
Should you consider the need to move some of your capital into investments or are considering additional investments or ISA transfers, either plan could be a compelling opportunity for a competitive level of fixed income while offering your initial capital some protection against a falling market.
Both plans are available as new ISAs, ISA transfers and non-ISA investments.
Click for more information about the Investec Enhanced Income Plan »
Click for more information about the Meteor 4 Year FTSE 4 Monthly Income Plan »
No news, feature article or comment should be seen as a personal recommendation to invest. Prior to making any decision to invest, you should ensure that you are familiar with the risks associated with a particular investment. If you are at all unsure of the suitability of a particular investment, both in respect of its objectives and its risk profile, you should seek independent financial advice. Tax treatment depends on your individual circumstances and is based on current law which may be subject to change in the future. Always remember to check whether any charges apply before transferring an ISA.
These are structured investment plans which are not capital protected and are not covered by the Financial Services Compensation Scheme (FSCS) for default alone. There is a risk of losing some or all of your initial investment. There is a risk that the company backing the plan or any company associated with the plan may be unable to repay your initial investment and any returns stated. In addition, you may not get back the full amount of your initial investment if the plan is not held for the full term. The past performance of the FTSE 100 Index or any shares listed within the Index is not a guide to their future performance.