The need for income is a foremost concern of every saver and investor alike, whether you are working and need to supplement your earnings, or retired and looking to add to your pension income. The need for income never goes away and with the current economic environment providing one of the most challenging on record, we take a look at one particular solution that is proving popular with income seekers.
Economic woes
The economic landscape is one that continues to offer little in the way of a positive step towards sustainable recovery and those looking for income are affected as much as anyone. Interest rates continue at 0.5% for well into their fourth year, many salaries have been frozen due to the pressures on business, annuity rates are at record lows creating uncertainty at retirement and all of this with inflation continuing well above target.
More worrying still is that as each day passes, it is becoming ever more apparent that no workable solution is likely to present itself any time soon and that any forecasts should be taken as just that. Therefore amongst it all, it is at least reassuring that there is an investment plan which on balance makes for a compelling option.
In a nutshell
The FTSE Income Accumulator from Morgan Stanley is a relatively straightforward investment to understand. This latest release offers investors a yield of up to 7% and has a fixed term of six years. Your capital is at risk if the FTSE 100 Index (the FTSE) finishes below 4,000 at the end of the investment term. This is known as conditional capital protection and is one of the plan’s main differentiators when compared to investment funds.
Potential for up to 7% income
This investment has already proved popular since its launch last week and one of the reasons is the potential headline yield of 7%. For each week the FTSE is between 4,500 and 9,000 points, income will be accrued with a payment being made each quarter. Should the FTSE remain at or above this level for each week during the quarter, the maximum income payment of 1.75% will be made.
This equates to a potential annual income of 7% and also means that should the FTSE drop below this barrier, you only miss out on income during those weeks rather than the whole quarter.
Quarterly payments
Another popular feature is the quarterly payment frequency since this provides a regular opportunity to receive an income payment while many equity investment funds only offer twice yearly payments. Therefore, not only does the investment provide the potential for a competitive level of income, but it also pays this on a quarterly basis which could be attractive if you are looking for the opportunity to supplement existing income.
Fixed term
The FTSE Income Accumulator has a six year fixed term and although you do have the option to withdraw your money early and in this respect is not dissimilar to investment funds, the plan is designed to be held for the full term and early withdrawal could result in you getting back less than you invested.
The fixed term will though appeal to those who wish to plan around this and combined with the potential for a high yield and quarterly payments, this gives a clear picture of what the coming years could yield. With the economic landscape looking uncertain, particularly regarding any change to interest rates, this could be seen as a viable option.
Conditional capital protection
When considering investment options it is important to understand the balance of risk versus reward. Inevitably, the opportunity to receive higher returns than might be available from cash deposits requires the investor to put their capital at risk.
Another feature of this plan which is attractive when making comparisons to other capital at risk income investments is the conditional capital protection. This means that provided the FTSE 100 Index does not fall below the 4,000 point barrier, you will receive a full return of your original investment.
This works separately to the income accrual and unlike a number of other investment plans in the market, has the benefit of only being measured on the final day of the investment rather than on each day throughout the investment term.
In the event that the FTSE does finish below this level on the final day then your capital will be reduced by the same percentage as the fall in the Index. For example, if the starting value was 6,500 and finished at 3,900, you would only receive a return of 60% of your initial investment as the final value is 40% below the starting value and below 4,000 points.
If, however, in this example the FTSE had finished at 4,100 point, you would receive a full return of your initial capital since although it would have dropped nearly 37% over the term, it is above 4,000 points. Therefore, the plan offers some protection against a falling market.
Compared to investment funds
Some of the current headline yields available from investment funds certainly catch the eye but it is important to remember that as with the FTSE Income Accumulator, these yields are not guaranteed and are subject to fluctuations. In addition, the treatment of your capital is different to the Morgan Stanley plan since there is no conditional capital protection – your capital is fully at risk on a daily basis.
This is an important difference since the income yield and any rise or fall to your original capital should always be considered together since both have an effect on your overall return. For example a 7% income yield is compelling in its own right but not so if it coincides with a 7% reduction in the value of your capital. However, this can of course work in your favour if capital growth is positive.
Compared to cash
Since this is an investment plan your capital is at risk. In this respect it is different to cash and the wide range of savings plans which offer to return your capital in full at the end of the term and are normally covered by the Financial Services Compensation Scheme in the event of default. This investment does, however, offer some protection against a falling market since your capital will be returned unless the FTSE is below 4,000 at the end of the term.
Although there is not a market for six year fixed rate bonds there has historically been a healthy market for longer term fixed rates with five year fixed rates traditionally offering the higher returns as compensation for you committing your capital for longer. Unfortunately the market here has been steadily declining and this investment offers the opportunity to more than double the leading fixed savings rates available in return for putting your capital at risk.
Risk v 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 you are taking in order to receive the potentially higher return.
Leading five year fixed rates are currently offering around 3% and so by accepting risk to your capital, you have the potential to more than double this rate and increase your income by up to 4% a year. With the market failing to meet the need for higher income the decision is whether you are comfortable with putting your capital at risk and the conditional capital protection offered in return for a potentially higher level of income and the potential to protect your income from the effects of inflation.
Credit ratings and agencies
Unlike a fund, your investment is used to purchase securities issued by Morgan Stanley and so their ability to be able to meet their financial obligations become an important consideration. This is known as credit risk and means that in the event of Morgan Stanley going into liquidation, you could lose future returns and 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 issued and regularly reviewed by independent companies known as ratings agencies. Standard and Poor’s is a leading credit agency and as at 23rd August 2013, Morgan Stanley has been attributed an ‘A-‘ rating with a negative outlook. The ‘A’ rating denotes a strong capacity to meet its financial commitments but could be more susceptible to adverse economic conditions than companies in higher-rated categories while the ‘-‘ signifies it is at the lower end of this rating grade. The negative outlook indicates that the rating may be lowered in the short to medium term (between 6 months to 2 years).
Morgan Stanley
Morgan Stanley is a multi-national investment bank and asset manager with operations in 36 countries. Established in 1935, they are one of the largest global asset management businesses with asset under management of $341 billion (as at March 2013). They employ over 54,000 people in more than 1,200 offices around the world.
Fair Investment conclusion
The market for income investments is full of attractive yields but it is important to fully understand how each works and the risks that one takes on. Whether this is inflation risk, risk of capital loss or fluctuating yields, it should always be remember that it is the income and capital loss/rise combined that effect your overall return.
Head of savings and investments at Fair Investment Company Oliver Roylance-Smith said: “Compared to other income alternatives available in the market, the Morgan Stanley Income Accumulator offers a compelling option. The headline yield is attractive and the cap on any income is balanced by the conditional capital protection included. This combines to give an attractive balance of risk v reward”.
With savings rates continuing at historically low levels and inflation rising, there is sizeable pressure mounting on savers to seriously consider what is the best home for their money. Unlike savings plans, investing inevitably puts your capital at risk and so unless you are prepared to lose some or all of your capital, this is not an option.
However, should you consider the need to move some of your capital into investments or are considering additional investments or ISA transfers, this could be a compelling opportunity to provide a competitive level of income while offering your initial capital some protection against a falling market.
The plan is open for Investment ISAs and ISA transfers and non-ISA investments.
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 may change.
This is a structured investment plan that is not capital protected and is 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 is not a guide to its future performance.