Since last year, there's been a sharp increase in the demand for products with regular payouts. These payouts may take the form of dividends or interest income, and in some cases can be paid out from the capital. The payments can be made yearly or monthly via the asset class (e.g. high yield bonds) or at a certain time for a fixed period, as in the case of structured products. The focus in pitching these products at the retail level is the payout, and often, investors tend to overlook or be unaware of the underlying risks.

This desire for high payouts can be traced back to the launch of capital guaranteed funds. At first, these products did not have a payout. Instead investors focused on the protection that was offered on the capital. For both capital guaranteed and capital protected funds, protection comes in the form of investing the bulk of the money in very low risk fixed income instruments (in the case of capital guaranteed funds, the capital is guaranteed by a bank). As time went by, payouts were added to these funds. By 2002, investor demand caused higher payouts to be added to such products.

However, as they were generally invested into long-term bonds and as interest rates were coming down, these structured products found it harder and harder to offer a high fixed payout. In 2004, high yield bond funds started to become popular, as the yield they could offer was high compared to structured deposits. Soon, after that, Asian high dividend equity funds were launched, and in 2005, we have seen a slew of property fund launches with payouts for each fund. Meanwhile, the demand for global bond funds has also been strong. Singapore government bonds, rated AAA, with yields higher than fixed deposits and a low sales charge, has also proved popular. Thus, the desire by investors for high payouts has not slowed, but instead increased over the past few years.

This initial desire for high payout investments dates back to the bursting of the tech bubble in 2000, and the subsequent volatility in global markets. For US investors, this type of volatility after a 20-year bull-run in US markets would be particularly jarring. For Asian investors, markets have always been volatile. However, the extent to which Asian markets have fluctuated since the 1997 Asian financial crisis has caused many investors to have very short-term view of the market. Market volatility is not seen as a long-term tool to help improve returns. Rather it is to be avoided at all costs. Thus, the relative "safety" factor of an investment that offers an above average yield is appealing to many investors. This regular return becomes a buffer that they can rely on. And in light of the volatility in markets and the low interest rate environment, investors reason that a steady income 4-5% annually, is more than enough to meet their needs.

In the past, when interest rates were higher, global investors could get a relatively high yield simply by investing in a long maturity bond. A 10-year US bond in 1991, held to maturity, came with little risk and offered a yield of as high as 8%. However, as interest rates in many parts of the world, including the US came down, it became harder and harder to obtain high yields even by going into long maturities. Today, for example, that same 10-year US bond will only give a yield of 4.5% (see chart 1). Yet, the demand for "yield" continued. Thus, when riskier investments offered a higher yield to investors, the demand for such investments rose. This led to their prices rising and investors witnessed their capital values grow in addition to the yields they were getting.

Chart 1

This has reinforced the demand for high yield products. Fund houses and banks have launched a myriad of products to cater to this demand. However, the underlying investments used to generate high yield for investors is very different from long maturity bonds. These instruments are riskier and some, after going through a substantial capital appreciation due to strong demand, have potential downside. At the same time, structured products continue to be in demand because markets have been volatile, and they offer protection plus a payout. However, because of low interest rates, even the payouts offered by such structured products are very low if the "upside" element is not taken into account.

Read the full article in the latest Fundsupermart magazine.

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(The magazine will be available on news stands from next week; Fundsupermart investors with minimum S$10,000 in holdings should receive their complementary copies by 5th April 2005)