How to play the yield

Flick open the business pages of any newspaper and there is every chance you will find pundits advocating a defensive investing strategy for these turbulent times.

A defensive strategy is a fancy name for what used to be called cautious investing. It is low-risk investing with the goal of steady yields and less volatility.

Bonds tend to be seen as the most popular of defensive investments because they generally yield more than plain old bank deposits. In Hong Kong, however, investors benefit from the fact that local banks offer an impressive array of deposit options in a large variety of currencies. But beware because banks seem to be pushing so-called special deposits in foreign currencies, which are great for the banks but generally terrible for customers.

In essence they are nothing more than a 'heads I win, tails you lose' option for bank customers. Investors are invited to take out a foreign-currency deposit for a fixed period (usually one month), with the tempting offer of higher returns than the prevailing interest rate on that currency. However, to get the higher yield you need to fix the conversion rate at a figure often substantially less than the prevailing rate.

If the conversion rate drops to that level, the customer gets the higher rate of interest. If it does not, they get nothing (however the original investment is returned).

What this means if that if you pick, say Australian dollars, and the Hong Kong dollar conversion rate rises relative to the Ozzie, you do not benefit from the price rise but get more interest.

The problem is that the higher interest, over a one-month period, is rarely better than the gain that would be realised simply by investing in the currency and benefiting from the Hong Kong dollar's appreciation. Amazingly these no-win, supposedly defensive savings plans, are highly popular.

Bonds are a clearer proposition, although there is a paucity of choice in local issues, aside from the understandably popular Hong Kong government iBond offering, which yielded very good returns for those allocated bonds when they were issued but more modest returns in the secondary market.

That tends to leave Hong Kong investors with the option of US dollar bonds, which, given the fixed link with the local currency, carry no currency risk. US Treasury bonds are now offering peanuts by way of yield, but US corporate bonds, particularly towards the lower end of the investment grade offerings, are paying over 3 per cent more than US Treasuries. Yet even at this level, their yield is the lowest since 1965.

So, this leaves equities as the best yielding of the current crop of defensive investments. Generally speaking, high-dividend stocks ('high' as a proportion of their price but not necessarily in absolute terms) are laggards when it comes to price increases. But their value shows up in price/earnings ratio comparisons, where value is measured by comparing the share price to the company's earnings. High-growth stocks tend to look expensive on this measure.

In Hong Kong, most of the best value blue-chip 'defensive' stocks are found among locally listed mainland banks, which yield almost double the prevailing average of 3 per cent. Investor caution over mainland banks makes a great deal of sense. Rather unusually, the share price of both HSBC and its associate, Hang Seng Bank, yields dividends of about 5 per cent.

However, the perennial best performer among defensive stocks is Swire Pacific (A and B Shares) yielding about 7 per cent and trading on a very modest P/E ratio of around four times. Yet investors seem to be wary of Swire because its highly diversified business is hard to understand and because its highest profile asset, Cathay Pacific, is deemed risky. But the shares appear to have finally emerged from the doldrums. They are now hovering around a 52-week high; something that can be said of few other locally listed stocks.

In all events most shares yield way above bond and bank deposit rates. The reason for this, of course, is the perceived greater risk of equities. But as Hong Kong companies are generally cash rich and in a better place than many of their overseas counterparts, maybe the stock market is the best place to find defensive plays.