Practice: Cash Flow and Liquidity There are many practical reasons why some investors like to receive returns in the form of income rather than in capital appreciation. Cash Flow and Liquidity : Pension funds and insurance companies may want a steady income stream to meet liabilities, match cash flows or hedge. Pension funds typically use the income as a source of regular cash flow to meet pension payments, in addition to contributions from active members and the sponsor. The current low-yield environment promotes the use of dividends as an alternative source of income. Investors who believe inflation may rise often prefer equity income. Most bonds are nominal assets, whereas companies with pricing power can pass on inflation to consumers, thereby preserving capital value and real dividends. Dividend income is also generally less volatile than asset valuations, making it attractive to investors who place a greater value on predictable returns. Many foundations and charities have adopted this approach. In addition, increasing numbers of people retire with large pots of savings and want to draw down their assets in a structured way. To avoid falling into the “dollar cost ravaging” trap we discussed earlier, equity income investments may offer an attractive solution. Liquidity Liquidity—buying and selling securities with minimum price disturbance—dries up in a market crisis. This means some investors will be sellers at a time and at a price that is not of their own choosing. Investing in high-yielding assets, including dividend-paying companies, reduces or avoids the need to sell assets during those periods. This is why a lack of liquidity can provide a powerful reason for income investing. It is especially attractive at a time when some fixed-income markets have frozen up, particularly in the eurozone. Bid-offer spreads widened and markets became shallow as the European debt crisis intensified toward the end of 2011. Investors’ desire for liquidity is reflected in valuations of hard- to-trade privately held companies. Private firms are typically valued at sizable discounts to comparable publicly traded firms (Stanley Block, 2007,”The Liquidity Discount in Valuing Privately Owned Companies”).
Posted on: Sat, 20 Jul 2013 22:36:15 +0000
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