There are three main 'asset classes' when investing. Fixed Interest, Property and Equities (Shares). These are then often separated into New Zealand, Australian and International sub categories. It is easy to think that the Fixed Interest asset class is straightforward and the easiest to understand, but unfortunately, it is actually the most complicated.
Calling the asset class 'Fixed Interest' is really a misnomer. This implies that the investments are 'Fixed', that they have 'Interest' and therefore that the 'Interest' is 'Fixed'. The reality is that within the 'Fixed Interest' asset class there are many different kinds of investments available, some of which do not have a 'fixed term' (perpetuals), Some interest rates can be 're-set' on an annual basis, and apart from Term Deposits, the value of the investment can change minute by minute.
It has been suggested that the asset class should be 'debt securities', as the main thing that all these investments have in common is that the 'issuer' is borrowing money from the investor.
What are the main kinds of 'Fixed Interest' investments available?
Term Deposits are the first kind of Fixed Interest investment that investors become aware of. Here you are 'lending' your money to the Bank/Financial Institution. You choose how long you are going to be investing for (3 months to 5 years.)
You then get paid an interest rate that is usually higher for the longer term investments. Your money is then 'locked up' for that time period. (In general, you can 'break' your term deposit with a bank and lose most of your interest due - but this is at the financial institutions discretion, and they can say no.)
Your interest is paid into your investment monthly, quarterly, annually or 'at maturity' and you can choose whether to have these funds compounding or not. Your capital investment remains the same. When making a Term Deposit, you need to consider the financial stability of the financial institution (look at credit rating) and the interest rates/time period for investment.
Within the 'Term Deposit' type investments are 'debenture stock' and other 'Term Deposit' type investments with non Bank Financial Institutions.
Government Bonds When you lend to the Government in New Zealand by purchasing Government Bonds, this is generally the 'lowest risk' 'Fixed Interest' investments that you can purchase. This is because the NZ Government has a strong credit rating, (AA+ by Standard and Poor’s Ratings Group, AA+ by Fitch Ratings and Aaa by Moody’s Investors Service.).
The Government can raise money to repay you by increasing taxes.
Government Bonds are issued in 'tenders' or by 'syndicated issue' or 'private placement'. When Government Bonds are issued, they are only available to 'persons whose principal business is the investment of money or who, in the course of and for the purposes of their business, habitually invest money. As a consequence, the wholesale offer does not constitute an “offer to the public” as defined under the Securities Act 1978 (“the Securities Act”) and is not subject to the provisions of that Act.
What this means is that as 'small' investors, you cannot purchase Government Bonds directly when they are issued. You have to purchase them on the 'secondary market'. More information on that is in this blog post Fixed Interest Secondary Market – a what???
Fixed Interest Managed Funds
There are thousands of Fixed Interest 'securities' available to invest in in New Zealand. As 'non term deposit' investments are traded and valued minute by minute, the values of these securities, and the most suitable securities to hold are continually changing, at Moneyworks, we prefer to use fund managers to provide access to diversified portfolios of fixed interest investments.
We are continually researching the most appropriate funds to use for our clients and at present we use a combination of funds from AMP Capital and Tyndall Investment Management Ltd. Which funds are applicable for each client, and in what proportions is an ongoing analysis and adjusted to each client.
Where clients have bigger portfolios, from time to time we add 'Direct Bonds' or 'Term Deposits' which are held to maturity. As the minimum investment tends to be $5,000 or $10,000 there are a number of factors that take into account when adding these to portfolios, including diversification, time to maturity, credit rating, risk and suitability to that clients portfolio.
With Fixed Interest Managed Funds the fund manager continually reviews and manages and buys and sells the investments in the portfolio. Their goal is for stability of capital value on the portfolio and to provide investment returns on the portfolio, so they are monitoring and changing the underlying investments as the economic environment changes.
As interest rates fall, Fixed Interest Securities (non Term Deposits) and Fixed Interest Managed Funds, can get a capital gain. Conversely, as interest rates increase, these investments can get a capital loss.
Therefore, it is important that your fixed interest exposure in your portfolio is continually monitored and reviewed and changed for the economic and investment environment as is applicable.
To understand Fixed Interest in more detail, look at these other blog posts.
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By Carey Church