The OCBC SGD Income Plus Fund (click here to read factsheet) is an absolute return fund that can invest in both global equities and bonds. It's benchmark is the 1-month SIBID + 1.5%, and the primary aim of the fund is to provide regular income yield whilst maintaining relative capital stability. OCBC Asset Managment has said that the fund will pay a fixed annual distribution of 3.5 cents per unit in 2005, 2006 and 2007, and from 2008 onwards, the intention will be to distribute at least 2.5 cents per unit annually.

This fund has no fixed allocation between bonds and equities. According to the fund house the bond portion of the fund will be managed similar to its flagship OCBC Global Bond Fund. The equity portion of the fund will initially be tilted towards Asian stocks that pay dividends. Fund manager Tan Hoe Heng says that as the market is now entering a period of modest gains, such stocks are more likely to outperform. In this email interview, he talks more about the fund.

Q: What is the current allocation between bonds and stocks? Are you overweight in a particular asset class at this point in time?

A: The return from investing in Income Plus will primarily be in the form of a regular income stream through quarterly income distribution, with stability of capital. As such, this fund will be managed using an absolute return strategy. Hence, the investment approach is not so much overweighting one asset class or underweighting another relative to a benchmark. For Income Plus, the size of a particular asset class to be included is dependent on two considerations. Firstly, we are adopting a bottom-up approach to stock selection, and therefore the equity weighting is a result of the number of attractive stocks that we could identify on the ground. Secondly, the allocation between equity and bond is also subjected to the investment team's market outlook and the best mix that is likely to beat the absolute benchmark of 1-month SIBID + 1.5%.

Q: Quite a few funds that invest in Asian dividend yielding stocks have been launched this year. Is there a growing trend towards investing in this asset class?

A: I believe that the focus on stocks with high dividend yield just reflects a return to value investing. As we all know, value investors look for stocks with low PE ratio, low price-to-book ratio and high dividend yield. Such stocks tend to perform well in the long run. There is evidence that Asian high dividend yielding stocks have enjoyed good performance in the last few years and we believe that this trend will likely continue.

There are several reasons for the good performance of such stocks. Firstly, we believe that markets are entering a period of modest returns. As a result, dividend yield plays a more important part in determining the total return and capital gain a lesser role (i.e. Total return = capital gain + dividend yield). Hence, investors are paying more attention to stocks that pay dividends and valuing them higher.

Secondly, dividend yield used to be associated with 'boring' companies that have gone ex-growth, and are returning their cash to shareholders. However, this is no longer true in today's environment. Companies are more conscious of managing their capital effectively. Returning cash to shareholders is one of the ways to optimize the capital structure. Therefore, paying dividends is no longer viewed as a sign of poor prospects for the company.

Lastly, some investors are disillusioned by the accounting profits published by companies after several corporate scandals worldwide. Dividends, on the other hand, are something that investors actually receive. It is a vote of confidence on the financial strength and performance of the company. Investors appreciate such companies that reward them with yield for holding onto their stocks.

Q: How does this fund stand out from similar funds that invest in Asian high dividend stocks?

A: This fund is managed on an absolute return basis, unlike most balanced funds that are managed against a relative benchmark. As a result of the emphasis on absolute return, the fund is given the flexibility of allocating investment between equities and bonds, and the flexibility to invest globally.

This difference will be valuable at exceptional periods. For example, if Asian equities enter a bear period, the flexibility to allocate more money into bonds will come in handy, compared to a fund that can only invest in equities or has a fixed allocation to equities. In the same scenario, the flexibility to invest outside Asia will also be useful, compared to a fund that is restricted to investing only in Asia.

Compared to sophisticated 'high tech' derivative strategies, using equity/bond allocation to achieve absolute returns looks deceivingly simple. However, we believe such a simple method is very effective. For example, MSCI Asia Pacific ex-Japan index lost about 21% in SGD term in 1997 while Citigroup World Bond index gained about 20%. A 50/50 allocation would leave investors in small negative territory but just a 10% of asset from equity to bond would have resulted in positive return.

In OCBC Asset Management, we have an established track record in managing absolute return mandates. For example, the OCBC Global Bond Fund is managed on an absolute return basis and has produced an average annual compounded return of 4.6% (on an offer to bid basis, since inception to 30 September 2004, with dividends reinvested net of charges payable upon reinvestment and in SGD terms). The success in managing absolute return mandates for our institutional clients has therefore lead us to develop this fund for retail investors. What this means for investors is that they do not have to worry about making asset allocation decisions.

Another feature of this fund is its regular income distribution to investors. While distribution is not guaranteed, it is the Fund's intention to make an annual distribution of 3.5 cents per unit in 2005, 2006 and 2007, payable quarterly**. Thereafter, the fund intends to distribute at least an annual distribution of 2.5 cents per unit, payable quarterly.

Q: What kind of investors would be keen in this type of fund?

A: This fund is designed to meet the needs of investors who are looking for a fund with regular income distribution and moderate risk, and which they can hold for the long term. Investors need not worry about exiting and entering markets because that's done by the fund manager. For example, if you invest in an equity fund and believe that the equity market is peaking, you will have to decide when to sell your equity fund and switch the proceeds into a bond fund, and vice versa. We will make that decision for investors by allocating between equities and bonds within the fund.

Q: What are some examples of the high-dividend yielding stocks that the fund could invest in?

A: Chunghwa Telecom in Taiwan is an example of the type of stock that the fund may invest in. Chunghwa Telecom promises a dividend yield more than 7%, trading at 11 times 2005 PE. The telecom business offers good earning visibility and generates sustainable free cash so that the company can pay good dividends.

Another example is Hang Seng Bank which gives close to 5% dividend yield. Hang Seng Bank, a member of the HSBC Group, is the second-largest locally incorporated bank in Hong Kong. It has the right customer base to capture new business from SME banking, wealth management and credit card/personal loans. We are also interested in REITs (real estate investment trusts) listed in Singapore and Australia. Capitamall Trust is an example in Singapore that yields 5.8% and focus on the segment that we like - shopping centres. The Australian property trusts has a longer established history and we are looking at stocks such as CFS Gandel and Westfield Group.

Q: Besides the annual payout, what is the kind of capital appreciation investors can look at?

A: Beside dividend and bond yield that the fund receives, there is also potential for modest capital appreciation resulting from the carefully selected basket of stocks in the fund.

Q: What is the process for sieving out the stocks and bonds for your fund?

A: When selecting equities, we aim to select companies with good earnings and cash flow potential that are likely to deliver attractive dividends consistently in the long term. The equity portfolio will be constructed from a quantitative screening and rigorous bottom-up research. Risk management, with an emphasis on portfolio diversification, will form an integral part of the investment process.

The quantitative screening will help to identify a suitable list of stocks with dividend yield above market average, reasonable valuations and market size (liquidity). Then the country specialists and industry analysts will be consulted on the fundamental factors of these companies, such as strong business franchise, good earnings growth and improving cash flows. Finally, it boils down to a qualitative evaluation of the company by the specialist and myself.

When selecting fixed income instruments, we will evaluate credit quality through an analysis of the fixed income instruments. Our fixed income specialists will conduct an analysis to identify under-valued and over-valued securities of the bond issuer. In addition we will research five principal areas, namely, country, duration, yield curve, currency and credit. The managers will also diversify the risks across the 5 areas to achieve the performance objective. To give an example in the area of currency, we are of the view that the SGD would take a path of gradual appreciation and then we could tilt the bond portion towards SGD-denominated bonds.

Q: What are the other instruments that the fund manager can invest into, besides global bonds and Asian equities?

A: The investment mandate of this fund is global bonds and equities. Thus, the fund can choose to invest outside of Asia. However, we choose to invest in Asia Pacific (ex-Japan) equities in the beginning because this region offers investors a higher dividend yield than the world average. Stocks in Asia Pacific (ex-Japan) currently yield a dividend rate of 3% and the trend is improving because companies are able to pay out higher dividends as a result of improving cash flow. Through our company visits in Asia, we also sense that company management are more willing to pay more dividends out of their earnings. Besides offering higher dividend yield, Asian stocks on average trade at lower PE and price-to-book compared to the world average. PE of MSCI Asia Pacific (ex-Japan) is 14.4 times compared to 17.4 times for MSCI World, while price-to-book is 1.9 times compared to 2.3 times (as at September 2004).

Again, we must stress that the fund has the flexibility to invest globally. This flexibility is necessary to achieve our aim of generating positive return for the investors because a particular region might not be attractive to invest at some point in the future. The fund can also invest in equity-related securities including, but not limited to, preference shares, real estate investment trusts, depository receipts.

Q: Briefly, what's the outlook for global bonds and equities in the next 1-2 years?

A: As mentioned earlier, we believe the equity market is entering into a period of modest return. The near term outlook for the Asian stock market will be driven by the re-acceleration in global growth and the benign inflation. The US ISM manufacturing index for September stood at 58.5, indicating continued economic expansion. In Japan, the October Tankan survey was also indicative of economic re-acceleration. While oil and other commodity prices remained a risk factor for Asia, we noted that this region has the exchange rate flexibility to tame imported inflation in the near term. With valuation on its side and global growth remaining relatively strong, Asian stock markets are expected to attract foreign inflow of funds.

Again, I must emphasise that this fund will be managed on a bottom-up basis that will be further refined by a top-down analysis. While we take into consideration our in-house macro views, the most important criteria to stock selection remain the company's fundamentals.

For fixed income securities, the bond markets have significantly discounted interest rate hikes. We do not expect any sell-off in the US bond markets as in 1994 when the Federal Reserve raised interest rates sharply. In the case of Singapore, the yields may see only modest upward movement given the ample liquidity in the banking system and low inflation.

**In Year 1, the Managers intend to make the first distribution of 1.75 cents per Unit on 30 June 2005 (book closure date) and subsequent distributions of 0.875 cents per Unit on the last Business Day of each of the two subsequent calendar quarters in 2005. In Years 2 and 3, the Managers intend to make quarterly distributions of 0.875 cents per Unit on the last Business Day of each calendar quarter and thereafter, quarterly distributions of at least 0.625 cents per Unit on the last Business Day of each calendar quarter.