There are many income sources to consider, each with different characteristics such as income volatility and risk levels. By gaining an in-depth knowledge of these, investors should be able to find suitable options to broaden their investment income.
Income funds: These are mutual funds with payout characteristics that typically distribute dividends at regular intervals. Generally, the dividend yield is not guaranteed, but as is the case with any diversified portfolio, the likelihood of every holding simultaneously failing to distribute is small. In addition, the fund manager is allowed to pay dividends by profit-taking (capital gains), or even out of the capital. Therefore, the chance for investors receiving no income is relatively low.
Real Estate Investment Trusts (REITs): REITs are legally obliged to distribute the majority of net income after tax as dividends. They cannot suspend payouts due to economic or business factors. As long as a REIT records positive net income, unit holders are entitled to dividend payouts.
Preferred securities: Preferred securities are hybrid securities with equity and bond characteristics. They are usually issued by large, tightly regulated institutions and companies, such as banks or utilities. The dividend yield is generally fixed. These entities typically have larger and more stable cash flows, enabling them to pay dividends. Their default rate is also lower than that of high-yield bonds.
Options: By selling a call option or put option, investors can receive a premium (income) in advance without waiting until the option expiry date. However, it should be noted that obtaining a premium does not necessarily mean that the overall investment return is positive. If the trend of the underlying asset deviates from expectations, i.e., the price of an asset actually rises after selling a call option, or vice versa, overall returns may be negative, as the premium may not be adequate to offset the loss on exercising an option completely.
(Income Series, Part 2 of 3)
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1 Source: Default rate of global high-yield bonds and global investment-grade bonds provided by Moody's Investors Service, Inc. Default rate of preferred securities during 1990–2017 calculated by Wells Fargo. As Wells Fargo stopped providing the relevant information after 2017, Manulife Asset Management has calculated the annual default rate based on the ICE BofAML US All Capital Securities Index since 2018. As of 31 December, 2019. Past performance is not indicative of future performance.
2 The above material is for illustration purposes only. Distribution of dividends, the frequency of distribution and the amount/rate of dividends are not guaranteed. Positive distribution yield does not imply positive return.
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