There are lots of ways to generate a passive income. In the UK, many of us go down the buy-to-let route, which can be lucrative. But my preferred option in investing for dividends.
So, this why I say forget buy-to-let, and instead, I focus my attention on stocks like Phoenix Group (LSE:PHNX).
This FTSE 100 insurer currently pays an 11.2% dividend yield, making it the strongest dividend payer on the index.
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Investing for dividends
Investing with a view to generating income via dividends is often considered an easier and more accessible option than buy-to-let real estate for several compelling reasons.
First, investing in dividend-paying stocks doesn’t require the substantial upfront capital needed to purchase a property.
In the case of stocks, I can start with a modest amount of money, making this option accessible to a broader range of investors.
Additionally, there’s no need to deal with property management, tenant issues, or the associated costs and time commitments that come with real estate ownership.
Moreover, I can open an investment account in a matter of minutes. Investing in dividend-paying stocks is very simple.
Nonetheless, I need to be aware that investing isn’t risk-free and I need to research my investments.
Investment hypothesis
One reason why the Phoenix yield is so high is because the share price has been falling. This is partly because of the impact of higher interest rates on the company’s bond holdings.
Insurers handle significant amounts of capital, which they later distribute to policyholders in the form of payouts.
These financial obligations must be carefully managed, leading companies like Phoenix and their counterparts to invest the managed funds, often in secure fixed-income assets such as bonds.
However, the recent trend of rising interest rates has led to a decrease in the value of older bonds and other assets.
Nonetheless, it appears that things will improve here. After all, interest rates will need to moderate over the medium term.
Moreover, these bond losses are ‘unrealised’. In other words, insurers likely had no intention of selling these bonds. They’re held to maturity as part of a balanced portfolio of assets.
Of course, that’s not to say further interest rate hikes wouldn’t push the shares lower. Higher interest rates tends to draw money away from shares, towards debt and cash in addition to pushing down the price of older bonds.
More tailwinds
Second, we’re also see positive trends in general insurance with inflation moderation. Thus, there’s less pressure on insurers to continually stay ahead of rising claims costs.
This has been reinforced by a more than twofold increase in new business long-term cash generation that surged to £885m.
The group’s performance has also been buoyed by positive trends in the bulk purchase annuities (BPA). These are insurance contracts where a pension scheme transfers its liability to pay pensions to an insurance company.
This helps the pension scheme manage its financial risk by ensuring that the insurance company takes responsibility for making the pension payments to scheme members.
Phoenix Group is by no means the biggest player in the BPA market. However, it’s a growing industry, that was worth £50bn in 2022 and could more than double in the coming years. To date, only 15% of the UK’s defined benefit pension liabilities have been transferred to insurers.
