TRANSCRIPT: Fixed Income – How Millionaires Avoid Stock Market Crashes

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Welcome back to Compare Return.

This is the complete introduction to how you can take (as an expat) a lump sum of money and turn it into an income generating stream for retirement – and how to avoid being scammed. We’re going to go over four sectors. We’re going to look at bonds, we’re going to look at structured notes, we’re going to look at investment properties and we’re also going to look at loan notes.

The reason why I’m doing this video today is because a couple of weeks ago I was actually approached to conduct some research into the sector. Complex derivatives are something that I’ve worked in for many years now. I’ve got a real passion for it and I thought, “If I’m doing 15 to 16 hours of research – screens on screens on screens of bonds and all these different product providers – why don’t I just give you guys a little bit of a background on it as well?”

Living offshore can give you some fantastic opportunities for investing, you’ve got the best of both worlds. You’ve got access to all the traditional markets you’d have access to in your home country but also everyone else’s home country. UK, Australia, US, you name it – but you also have access to the offshore markets and there can be some fantastic investments in those as well.

Fixed income and why today? Why now? It’s because in the current interest rate climate – if you go out and loan your money to the government you might be lucky to get one percent, maybe one and a half percent. If you go to a bank – same deal. On your US dollar and on the Euro – negative interest rates. You might get half a percent or one percent return when traditionally you might have got five or six percent return that today is not out there.

In the next things we’re going to be talking about, some of these do return you some fantastic returns. Four percent all the way up to 12 percent returns. You can get a decent basket if you know what you’re looking for. Today I’m going to show you how.

Fixed income, at its most basic, is loaning money. Whenever you’re lending money to someone you need to be careful and in this video I’m going to show you what to look for with these structures, the devil really is in the detail. As always, this isn’t meant to be taken as financial advice, this is just my opinion. Please seek the advice of a professional or educate yourself.

Ryan: I’d like to introduce you to today’s investor, which is Trevor. Hey Trev, how are you going mate?

Trevor: G’day mate. Cheers for having me on your telly show. I’m going to be able to brag to the boys down the pub that I’m on the telly. Nice to meet ya!

Ryan: Whereabouts are you coming to us from Trevor?

Trevor: I’m out in rural Queensland.

Ryan: So, my first question for you today is: Are there any parts of Queensland that aren’t rural?

Trevor: Ah yeah nah yeah no not really. Okay anyway I’ll tell you a bit about myself. I’ve done all right for myself. I’ve been out in the rigs for probably 30 years now. I stepped up as a junior and now I’m sort of running the show, but you know mate I’m getting a bit long in the tooth. I figured it’s time for me to pull up stumps and sort of head off home. The kids are all grown up, the missus is happy, so yeah time for me to retire. Got a couple million, so not doing too bad for myself but I want to put about $500 000 of that into some fixed income so I can get myself about a $35 000 a year return. So that’s kind of what I’m looking for – six or seven percent – something around there is kind of what I’m looking for mate. If you can do that for me, I’ll be a happy camper.

Ryan: Well, it sounds like you’ve got a pretty good understanding of what you’re looking for mate so let’s get stuck into the video for today and I hope this helps you out.

Trevor: Cheers for that. I look forward to it. Let me know what you come up with.

Ryan: For Trevor I’m using the ‘five bucket’ approach. I’ve also got a link in the description below. It’s a whole video on how to diversify yourself correctly for retirement. He can really ensure that this structure is going to give him a decent foundation to work from moving forward and most importantly give him a dollar income that he knows is going to be income that he can then spend for retirement.

Category one is corporate bonds. At its most basic, a corporate bond is a loan to a company for a predetermined period. In return that company agrees to pay you an income, or interest, which is typically twice a year. It might also be annually, it might also be quarterly, it could also even be monthly until that investment or the bond matures. Let’s use a typical fixed rate bond as an example. If you invest a thousand dollars for a ten-year bond that’s going to be paying you three percent per annum, they’re going to be paying you $30 a year and they’re going to give you back your original thousand-dollar investment in a decade’s time.

When you’re buying bonds there’s typically three ways to buy them. The first way is a new issue. A new issue is where you go into the market and for example, Xerox is looking to generate a hundred million dollars of revenue for the company, and they do it in the form of a bond that they’ll put out to market. It’s not yet subscribed or they’re taking subscribers on. That’s the first way.

The second category is the secondary market. What that means is say for example if a bond was over 30 years, someone gets 15 years into it and they want to sell. You can actually go out onto the secondary market for approaching people like brokers that are able to settle you with that bond. The thing to keep in mind about that is that these will have a net asset value. They’ll trade at either a premium or a discount. For example, if 15 years ago Microsoft was paying you eight percent per annum because interest rates were higher, today that will typically trade at a premium. What that means is to get into it, it might be now valued at 130 percent. What I’m trying to tell you here is that there’s no magic, secret unlockable door in the bond market that’s going to get you fantastic returns that your financial advisor didn’t tell you about. Don’t jump onto Google and google bonds and tell your financial advisor that you’ve seen this for 10 percent and they don’t know what they’re doing, because typically those are yield adjusted, so you’ve got to keep that in mind.

The third category is bond funds. You might want to get on board with an exchange traded fund or a fund that buys ladders. For example, if that bond has a million dollars in it then it might be broken down into a series of different corporate bonds. HYG ETF is a classic example of this. So that could be a good way for those that aren’t high net worth investors to get a little bit of exposure to the bond market. ETFs are traded on what they call a 30-day SEC yield which dictates how much you’re going to get back.

Why people typically invest in a bond (Microsoft, Dell, HP, take your pick, Xerox, Huawei, Apple… any major company) is because the returns are typically more stable than buying the equity. Say, for example, if Apple’s stock price crashes by 30 percent, unless Apple goes bankrupt the return of your bond is going to be rock solid. That means that you’re always going to be getting that money coming in. People typically pick bonds over equities because they’re genuinely looking for that fixed stable income for retirement.

The next category we’re going to be talking about is structured notes. I could probably do a whole video on structured notes just on its own. If you’d like to see that send me an email or tell me a little bit more in the comments. In layman’s terms, a structured note is a debt obligation that also contains an embedded derivative component that adjusts the securities risk-return profile. The return performance of a structure note will track both the underlying debt obligation and the derivative embedded within it. Sounds easy? Well, they’re not! Structured notes are complex derivative investments typically for sophisticated investors. To give you a proper layman’s introduction to structured notes (I was being a little bit cheeky before), the cost or the price or the value of my headphone case is derived by how much battery is left in my phone. If that’s still sounding a little bit complex, once again, they are complex, but what that means is the headphone case might be issued by Goldman Sachs. It’s going to be paying you five percent per annum as long as the battery in my phone doesn’t dip below 80 percent, which is the S&P 500. That’s the product and underlying it(or what it’s investing in) might be the S&P 500. It could be the FTSE. It could be any number of things. It could even be individual stocks and shares.

The great thing about structured notes is they can be created in a huge variety of ways that can provide you a fixed income return that isn’t typically able to be found anywhere else. Structured notes may offer increased upside potential. That might be a participation rate. For example, if a note’s giving you 150 percent participation in the S&P 500 (what that means is if the S&P 500 goes up by 10 percent in a year, the note might return you an income of 15 percent). They might also offer you minimum downside risk – they might have a market barrier. What that means is that a note will still return you eight percent per annum as long as the FTSE 100 doesn’t dip below 30 percent of its current value – that’s a 70 percent barrier. They can also be good at leveling out overall market volatility over a long period of time. Some structured notes can return as high as fifteen or sixteen percent per annum, even from companies such as Goldman Sachs, Barclays Bank or JP Morgan.

There are some fantastic offerings out there in this sector, but you really have to look at the following. The first one is issuer risk. Who’s issuing this structured note? If it’s ‘Dodgy Bob’s Bank’ down the road, the guarantee from them might not be worth the paper it’s written on. Make sure you’re only taking out notes that are issued by a trustworthy institution or alternatively make sure that the returns warrant that extra risk you’re taking on board. There’s also a ton of variety in them. Auto callable notes will pay you out once – so that might be compounding. It might be ten percent per annum. Which in year one it’s ten, in year two it’s 20 and in year three it’s 30. It’s only going to pay you out once but it’s going to pay you a big return. They might be quarterly income (which as the name suggests – return your income every quarter). They have market barriers built into them, they’ve got memory features, there’s a whole heap of things going on in these, and a lot of bells and whistles.

They are priced on the secondary market so if you do take out one of these notes one of the things you might notice is that it might trade at a discount. In other words, it might show as a loss on your portfolio. Don’t worry though, all that means is that you can sell out of these notes which is a good thing. There’s a secondary market so if you do want to sell them you can. The secondary market pricing is considered like this – you’ve got an agreement between me and you and the agreement is that as long as markets don’t dip by more than 30 percent per annum (that’s the S&P 500, the FTSE and say euro stocks or the Australian stock exchange) I’m going to pay you a 10 percent per annum income. That’s the agreement between you and me over a five-year period, so we’ve got plenty of time. If the market drops by 11 percent, the note might show that you’ve actually lost 11 percent, but you and I both know that the agreement is as long as it doesn’t drop by say for example 20 percent, you’re still going to get that income. That’s how they’re priced on the secondary market. There’s also issuer pricing, timeline to maturity, how close it is to an auto callable event, and a heap of other things.

Something to look out for with structured notes is – too many indexes that are not correlated. If it’s got say three indexes – it’s got the Indian index, it’s got the American index, and it’s got the Spanish index, three markets which might work inversely. You need all three of those markets to be hitting their trigger. If it’s got a 10 percent barrier, you might have America’s up 20 percent, Spain’s up 15 percent, but India down 20 percent so you continually miss out on your coupon. Trying to keep all the indexes together or at least close to being together is a good thing to look out for. One thing I will note about structured notes is you want to be careful with the correlation. For me personally I tend to stick away from emerging markets.

The next one we’re going to go over is investment properties. Like always, look at the comments section or the description in this video below. You’re going to find that I’ve also done a video on the three biggest mistakes expats make when buying investment properties. That’s typically being too emotional and not using leveraging. If you’re transitioning into retirement, you might not want to be looking at leveraging or taking out a mortgage for the property – you might want to own it outright.  The third thing is not picking the right company to work with. In my opinion investment properties are fantastic and everyone should have a little bit of investment properties in their portfolio but look for rental yields of four to six percent per annum. The other good thing about investment properties you get the capital growth so when it comes time to sell the property (if that property has grown from $100 000 to S170 000), you’ve also got 70 percent worth of capital appreciation you can work into your average yield over however long you’ve had the property. If you want to know more watch the video in the description.

The final category we’re going to talk about is loan notes. Basically, a loan note is just a fancy IOU. You lend money to one party with the agreement that they’re going to pay you that money back. Typically, with interest – that’s why we do this. These can come in many different shapes and sizes. It could be money being lent to a gold mining company for exploration. They then have five million dollars to go out for gold mining exploration. They’re thinking that they’re going to be diversified enough that they’re going to hit some gold and then they’re going to make 400 percent return on that gold mine and that’s going to allow them to pay back the investors. It could be in complex structured loaning where they’re taking out loans or micro loans (which is obviously a little bit more intangible or risky). They might be in litigation cases. It might be in construction. It could be in any number of things.

Let me give you an example of one of these. It might be that you’re lending money to a construction company. That construction company then goes out and completes projects. It might be building petrol stations, it might be building roadside retail, you know Starbucks, KFC’s –  all those kinds of things. Now that construction company knows that when they’ve completed a project, the return on their investment might be 300 percent and for that they’re happy to give you 10 percent per annum over a two-year period. That means that you’re loaning money to this company over a two-year period with the expectation that they’re going to pay you back the income and your original capital investment. The things to look for here might be, how many properties have they completed in the past? How many properties do they currently have under construction? How experienced is the board of directors? What’s their projection like? How many projects are they looking to do? Are the projects able to be seen on google maps? What’s their public presence? That’s just one example of a loan note.

One of the things to look for in loan notes is diversification – obviously, you don’t want to be putting all your eggs into one basket if you’re looking at this sector. The term – how long is it for? Is it over one year two years, three years, five years? The other thing to look for in the due diligence process – is the security? Is it asset backed? Are you investing in actual physical assets and do you contractually own those assets? If it’s something like insurance repackaging or micro lending, in that case you don’t. You own the capital of the company, so you want to be making sure the company’s books look really good. Also, is there any insurance? Is this company insured and do you get access to that insurance payout should the company go insolvent? These are all things you want to be looking at for loan notes.

If it offers a guarantee – who’s offering that guarantee? If it’s something like Barclays Bank and there’s 100 percent backstop at Barclays, well, that might be fairly stable. One of the ones that I found in my research had only been around for 13 months. It was registered, so I’m looking at the company’s registration on the UK companies house – they’ve only been registered 13 months ago. It had three members registered and one of them had already resigned. Of the two-remaining people, one of them was only 34 years old and the other person I couldn’t find any public information about. The actual investment structure was in something which wasn’t tangible – so there was no physical asset backing. For me immediately it went straight in the bin. So that’s loan notes. these can be fantastic. You can have returns of 10 to 15 percent in the market for these. You can get some good – fixed – income but the thing to make sure of, is diversification.

Ryan: So, back to Trevor! Welcome back Trev, did you watch the whole video – how did you find it? It appears that we’ve lost Trevor. My best guess would be that he’s probably already down the pub having a couple of beers.

Let’s go over Trevor’s situation. Trevor wanted to invest $500 000. He might want to invest in something  like 14 different investments over the four categories we’ve talked about. Obviously, investment property is going to be difficult to shoehorn into that but let me just give you this as an example. If you took half a million dollars and invested in 14 different investments, that would be $35 000 in each. If he’s got two million dollars’ worth of assets, that would represent 1.7 of his net worth. Nobody wants to lose $35 000 but if you can stomach that and it only represents 1.7 of your portfolio then your exposure isn’t that big as a percentage. That’s why you need to be very high net worth with these investments because if $35 000 represented 35 percent of your retirement pot – you’re going to be wiped out.

If you’ve got tons of different diversified investments in a deep portfolio-  good job! If in the past year you’ve earned more than $150 000 US dollars, or if you’ve got net assets over $350 000 that don’t include your primary abode the house you live in and doesn’t include your pension or any contract obligations or any insurances you’ve got – why don’t you and me have a chat about it? You’ll notice that I’ve also given you a Calendly link where you can book in and have a chat with me.

I love talking about fixed income investing, it’s something that I’ve got a real passion for (if you didn’t notice). If you don’t want to book in and have a chat, why don’t you tell me about it? Why don’t you send me an email? Tell me what you liked about this. Tell me what you didn’t like. You are my eyes and ears.

That’s been fixed income investing and how you can generate an income for retirement from a cash pot.

Hope you enjoyed the video today. As always, like and subscribe and all that sort of stuff. We’ll see you guys next week.


Please note that information on this website is strictly for education purposes only and does not constitute advice, please seek a licensed professional before investing. See more details here.

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