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OPINION

The best investment

The best investment
November 21, 2012
The best investment

As well as the merits outlined in the tip, the NatWest prefs have a vital attraction that I'll explain in a moment. First, though, let's focus on a specific benefit they will bring to the income portfolio. I have sourced almost all the cost of the prefs by selling around half the fund's holding in iShares Markit iBox £ Corporate Bond fund (code: SLXX). Behind that mouthful is an exchange traded fund (ETF) that tracks a total-return index of investment-grade corporate bonds.

Now, it's nice that corporate bonds are being rehabilitated by investors because that's pushing up their prices, and shares in the iShares bond fund are up 10 per cent since I bought them 11 months ago. But the shortcoming of getting exposure to corporate bonds via an index-tracking ETF is that dividend payments are falling as bond prices rise to reflect the diminishing yield component within the index's total return. So, overall, I am not as well off as I would be if I owned the underlying bonds. Yet I also know that if, for whatever reason, bond prices fell, then I would be partially protected by the rising yield component within the index's total return.

I can accentuate the positive of rising fixed-interest prices and reduce (though not eliminate) the negative of the falling income from this ETF if I combine it with the NatWest prefs. An approximately equal holding in each gives me continued exposure to the upside of rising prices and some protection against the downside thanks to the quirky characteristics of the ETF, but it also brings me much more income than from the iShares ETF alone. The yield on the ETF is now down to 4.0 per cent, whereas - despite its strong showing since the IC's tip - the running yield on the NatWest prefs is 7.4 per cent. So my weighted average of the two is about 5.7 per cent.

It also seems unlikely that the price of the NatWest prefs will be hit when - eventually - interest rates start to rise because its present yield is so far above the cost of money. Besides, rising interest rates are likely to reflect recovering economic activity and this would boost the profits of banks, thus eliminating lingering worries that NatWest's parent, Royal Bank of Scotland (RBS), will try to turn these cash-consuming prefs into equity.

But what about that vital attraction I mentioned earlier? To explain, consider that most of the time investors in quoted securities are beholden to the market for much - and sometimes all - of their investment return. That's a drag. It means always having to find investment theory's 'greater fool' to pay a higher price than we have done; it means being dependent on the manic market that giveth but often taketh away for no good reason.

It follows that just about the ideal investment is one where the investor is not reliant on the market's mood swings to make his return. The NatWest prefs - even at their current price - fit that bill. All I have had to do is buy them and each year I am almost guaranteed a 7.4 per cent income return. That's enough pretty well to fulfil my investment needs. Sure, I 'target' an 8.5 per cent annual return but, given the low risks involved with the NatWest prefs, I am quite content with 7.4 per cent a year on this slug of capital.

Meanwhile, do I really have to worry about what happens to the price of the prefs, which will affect the total return on this investment? Not a lot. If anything, I reckon they are still a bit cheap because their price remains depressed by the RBS connection. Exclude this and a yield of 6 per cent seems feasible, given interest rates elsewhere. That would push the prefs' price to 150p. Cataclysmic factors, such as further banking crisis or fast-rising inflation, could hammer the price. But these things are nowhere in view.

Lastly, don't focus exclusively on the NatWest prefs. Remember, I'm outlining a generic model - the ideal investment whose returns do not depend on the market.

MR BEARBULL'S INCOME PORTFOLIO     November 20, 2012
Shares bought  Date dealt  Price (p)  Cost (£) Price now (p) Value (£) Change (%)
2,285GlaxoSmithKline2.001,29029,4811,317    30,093 2
1,800SSE2.0363411,4941,360    24,480 115
4,500Carr's Milling1.0944019,924945    42,525 115
7,400Carillion5.0926719,900287    21,238 7
9,200Mitie11.1020418,887289    26,588 42
10,000Vodafone1.12178 17,929160     16,000 -10
12,000Ladbrokes8.12162 19,526185     22,200 14
120iShares £ Corp bond12.11£118.6814,255£130.30    15,636 10
13,150NatWest 9% Prefs11.12121 16,016117     15,320 -4
    Total   214,080
     Cash    24,547
   Interest accrued138
   Ex-divs1,013
Starting capital (Sept 1998) £ 100,000Total   239,778 140
FTSE All-Share index           2,384       2,933 23
Retail Price Index  16424449
Income distributed:£ 100,889