Investing

A chorus of commentators has conditioned investors to expect single-digit returns as a result of chaos in global financial markets. In a word, that’s lazy. Plenty of quality companies offer double-digit yields from shares and bonds, and other investment products and strategies provide high yield and a decent margin of safety.

This is no time for conservative investors to dive into shares for yield alone, unless they can hold shares for long periods and withstand paper capital losses. A better strategy is searching for quality investments that offer higher yields than cash, and safety through diversification or embedded capital-protection.

Time to get creative

Rather than move away from term deposits, one option is to become more creative with them.

Investors who have lost faith in the supposed diversification benefits of modern portfolio theory (such as holding a mix of cash, fixed interest and property in a balanced fund) might consider a radical approach of having a sharply higher cash allocation, and using leverage for exposure to assets with potential for capital growth.

For example, an investor might hold 92 per cent of a portfolio in cash and use the other 8 per cent to bet on aggressive ideas, such as gold, or use options or MINI warrants over stocks. Here, much more of the portfolio is tucked away in term deposits, and leverage is used to maximise exposure to assets that could generate a capital loss.

The 8 per cent of the portfolio at risk is focused on shorter-term ideas, with profits ploughed back into the term deposit, which in theory continues to grow and provides higher income.

A new portfolio theory

Alpha Structured Investments founder Tony Rumble says this strategy, popular in Europe and Asia, makes increasing sense.

“This crazy idea of modern portfolio theory simply has not worked after the GFC [global financial crisis], with even highly diversified portfolios suffering,” Rumble says. “As market volatility remains high, there is a good argument to have a permanently larger allocation to cash in your portfolio, and far lower equities exposure.

He says that this strategy has several benefits:

■ First, much more of your money is safely secured in cash.

■ Second, depending on the geared instrument chosen, an investor who bets 8 per cent of their portfolio on risk assets can still get the same type of growth exposure as if they’d invested a third or more of their portfolio in shares.

■ Third, the term deposit’s return will partly offset losses on the 8 per cent bet on a growth asset if the trade goes sour.

But beware ‘time decay’

The strategy’s downside is that instruments such as options and warrants are wasting assets due to time decay. A share might fall 30 per cent but can still recover for long-term investors.

“That’s true,” says Rumble, “yet if you think the sharemarket could easily fall another 10 per cent to 20 per cent, the argument about time decay is less valid. And if you choose geared products based on limited-recourse loans, then you are only risking the investment itself.

“This strategy is essentially about taking small bets, to help build your core investment in very low-risk assets with reliable income.”

A few suggestions

Rumble nominates the Deutsche Bank Access Certificate Series as a good way to execute this strategy. Investors seeking to build their own strategy could use term deposits and higher-geared products, such as MINI warrants or options. Alpha Super Shares or similar investment-banking products, which use an instalment and have a “walk away” feature, are another option.