Before the Global Financial Crisis (GFC), New Zealand had it's own meltdown with Finance Companies. Everyone learned a lot of lessons about the relationship between risk and return. The higher the risk, usually the higher the return.
OR - easier to remember, the higher the return, usually the higher the risk. But things get distorted when investors forget some of these rules. Over the last few months, we have seen a number of corporate bond issues come to the market that have very low returns for the risk that is involved.
When looking at options for our clients to invest in, we reviewed a number of corporate bonds that were either not rated by a ratings organisation, or did not have very strong investment ratings, and were returning around 5.25%-5.30% for a 2-3 year investment. We then looked at what the banks are offering for that time period. With some of the mainstream banks, with Credit Ratings of AA- an investor can get 5.00% pa for 2 years. The question we had to ask was 'Why would you take on the extra risk of a Not Rated or BB+ rated corporate bond to get 0.25% to 0.30% pa extra return?'
On behalf of a client who is a Trustee of a Family Trust, I reviewed the 're-marketed' NZ Post Bonds. These are perpetual bonds (that is they keep on rolling over with the interest rate 're-set' every five years, and don't come to maturity until 2039.) The rating on these Bonds from Standard & Poors was A-. It has just been revised and reduced by 4 notches - down to BB+. The guidelines that we use is that anything BELOW BBB+ is not investment grade. The interest rate on this offer was 6.35% pa.
We recommended that the Trust not take up any of the offering as the Trust's risk profile is low risk. In our opinion, corporate bond issuers are getting away with offering very low interest rates for the risk involved.
Unfortunately, with human nature it is easy to be seduced into higher returns without really thinking about the extra risk, or by not really paying attention to the risk of an investment offering and saying 'is this return worth the extra risk'?
It is vital that you think about this relationship when you are making your decisions. If Moneyworks are your adviser, we are continually thinking about this and will educate you on this and remind you about the relationship.
When I read the following excellent article by Diana Clement in a recent NZ Herald, I realised again that investors are forgetting these important principles. Peer to Peer Lending (P2P) is the latest way to raise money. Lets hope that investors don't get too greedy and that there isn't a whole new area of 'finance company disasters' about to happen. If you want to gamble with a little bit of money, these P2P loans only require a $25 investment. But if you are serious about keeping your money working, stick to the tried and true investments.
If you would like to meet with Moneyworks to discuss your financial planning and investment options, please contact us by sending an email to us at Carey@moneyworks.co.nz.
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