06 August 2013 / by Oliver Roylance-Smith
With so many savers joining income investors in the hunt for high yields, being able to quickly understand and compare the numerous options available has become even more important. We therefore compare two of our most popular income investments to help understand what is driving their popularity and why they might meet your income needs.
An all too familiar picture
By now, both savers and investors will be all too familiar with the harsh reality that we all face – record low interest rates, historically low savings rates, above target inflation, little economic growth and volatile bond and dividend yields. The picture is not a happy one.
Unfortunately, and perhaps worst of all, there appears to be little on the horizon that fills us with a sense that the end is in sight. Indeed, there is increasing uncertainty around what the coming years might hold in terms of the UK stock market and if we look at what could happen to inflation, the future is equally a cause for concern.
Perhaps the risk warning that should be made by every provider before a saver takes out a fixed rate bond is to make it quite clear that they will lose money in real terms unless inflation falls sharply and remains at a much lower level. One thing which is clear though is that the need to get the most from our savings and investments is higher now than ever before.
Income investments proving popular
Against all of this there are, however, a selection of income investments which are proving popular with investors which, by combining defined returns for a defined level of risk, are clearly striking a chord with those in the hunt for higher returns.
Both investments are relatively straightforward to understand. The FTSE Income Accumulator from Morgan Stanley offers investors a potential yield of up to 7% depending on the performance of the FTSE 100 Index while the Enhanced Income Plan from Investec pays a fixed income of 5.76% each year, regardless of what happens to the stock market. Both put your capital is at risk, the Investec plan if the Index falls by more than 50% and the Morgan Stanley plan should the Index fall below 4,000 points. This is known as conditional capital protection and is one of the plans’ main differentiators when compared to other types of income investment such as investment funds.
Fixed versus variable income
One of the main differences between the two plans is that Investec offers a fixed income while Morgan Stanley’s is dependent on the performance of the FTSE. The ability to be paid a high level of fixed income regardless of what happens to the stock market is clearly an attractive feature, especially when at 5.76% the income level is more than double the return savers could currently expect to receive from leading fixed rate bonds, in return for putting their capital at risk. This means that with the Enhanced Income Plan the investor has the certainty of knowing at the outset exactly how much he will receive each and every year.
The Income Accumulator Plan offers the potential for a higher income of up to 7%, but this is dependent on what happens to the Index. For each week the FTSE is between 4,500 and 9,000 points income is accrued, up to a maximum of 1.75% each quarter, equivalent to 7% each year. If the FTSE ends any week outside of this range you only miss out on income for that week, rather than the whole quarter.
Therefore, the main difference when comparing income levels of these two investments is either the potential for a higher yield, or accepting a slightly lower income in return for the peace of mind that this will be paid regardless of the performance of the stock market.
Monthly versus quarterly payments
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.
The Enhanced Income Plan makes a monthly payment, equivalent to 0.48% of your initial investment. Monthly income can be the most useful in terms of budgeting and is attractive when looking to supplement existing income. The Morgan Stanley plan potentially pays out any accrued income at the end of each quarter, thereby providing a regular opportunity to receive an income payment while many equity investment funds only offer twice yearly payments.
Fixed term
Both plans have a fixed term of six years and 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 though appeal to those who wish to plan around this and combined with either a fixed return or the potential for a high yield and quarterly payments, this gives a clear picture of what the coming years could yield. With so much uncertainty around when interest rates might rise, either investment could be seen as a viable option.
Conditional capital protection
When considering investment options it is important to understand the balance of risk v reward. Inevitably, the opportunity to receive high fixed returns or the potential for higher returns than might be available from cash deposits, requires the investor to put their capital at risk.
Another feature of these two investments which could be attractive when making comparisons to other capital at risk income investments is the conditional capital protection included in both – this means that the return of your initial investment is conditional on the performance of the FTSE. For the Investec plan, provided the FTSE does not fall by more than 50% of its starting value throughout the investment term then you will receive a full return of your original investment. However, if it does fall below 50% and also finishes lower than the starting value, your initial investment will be reduced by 1% for every 1% fall.
By comparison, the barrier for the Morgan Stanley plan means that provided the FSTE 100 Index does not fall below 4,000 points, you will receive a full return of your original investment. In the event that the FTSE does finish below this level then your initial capital will be reduced by the same percentage as the fall in the Index. Unlike the Enhanced Income Plan, this is measured on the final day of the investment only, rather than on each day throughout the investment term.
However, the 4,000 point barrier could be less than the 50% fall built into the Investec plan. For example, if the starting value was 6,647 (this week’s opening value) and finished at 3,988, 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). Either way, both investments do put your capital at risk and so there is a risk that you could lose some or all of your capital.
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 either a high fixed return or the potential for a higher return.
Leading five year fixed rates are currently offering around 3.0% and so by accepting risk to your capital, the Investec plan increases your fixed return by over 3% a year (since the fixed income from this investment is 5.76%) while the Morgan Stanley plan offers the opportunity to 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 the yields on offer 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 Investec and Morgan Stanley respectively 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 issued and regularly reviewed by independent companies known as ratings agencies. Moody’s is a leading credit agency and as at 4th July 2013, Morgan Stanley has been attributed a Baa3 rating with a negative outlook while Investec has been attributed Baa1 with a negative outlook. The ‘Baa’ rating means that both institutions are subject to moderate credit risk. They are considered medium grade and as such may possess certain speculative characteristics. The ‘3’ is at the upper end of this rating grade and ‘1’ is at the lower end. The negative outlook indicates that either rating may be lowered in the short to medium term (between 6 months to 2 years).
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 2013 they look after £96.8 billion of customer assets as well as a further £25.3 billion of customer deposits and employ around 7,300 people. They specialise in a number of areas, particularly within the banking sector and are a leading provider of investment plans and structured deposits.
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 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: “The high level of fixed income and the monthly payment frequency all go in favour of the Investec [Enhanced Income] Plan while the higher credit rating and the potential for a higher 7% yield make the Morgan Stanley plan equally attractive. With low interest rates and real uncertainties around future inflation, both plans provide a competitive balance of risk versus reward that could be considered by both savers and investors.”
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 should not be an option.
However, should you consider the need to move some of your capital into investments or are considering additional investments or ISA transfers, either investment could be a compelling opportunity to potentially provide a competitive level of 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 Morgan Stanley Income Accumulator 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 may change and may be subject to change in the future.
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 is not a guide to its future performance.
© Fair Investment Company Limited