In­vest­ing in Bonds

South Waikato News - - OPINION -

In un­cer­tain times, in­come gen­er­at­ing in­vest­ments such as bonds is­sued by Gov­ern­ments, lo­cal au­thor­i­ties and cor­po­rates, can play an im­por­tant role in your in­vest­ment port­fo­lio. The un­cer­tainty sur­round­ing not only New Zealand’s fu­ture eco­nomic re­cov­ery, but also global un­cer­tainty is likely to re­sult in bonds con­tin­u­ing to be a fo­cus of in­vestors for some time yet. Last week, the Euro­pean Cen­tral Bank’s Pres­i­dent, Mario Draghi an­nounced new mea­sures to sup­port Euro­pean economies un­der nan­cial stress, by agree­ing to buy bonds is­sued by Gov­ern­ments in the Euro Zone, sub­ject to cer­tain cri­te­ria. This is a pos­i­tive step to­ward re­cov­ery in the re­gion, with in­vestors re­spond­ing favourably to the news. Locally, ex­pec­ta­tions are that the Re­serve Bank of New Zealand will keep the Of cial Cash Rate at cur­rent lev­els well into 2013. Some economists have even sug­gested that it will be 2014 be­fore we see any rate rises. The like­li­hood of fur­ther in­ter­est rate cuts though has di­min­ished for now, un­less there is a fur­ther de­te­ri­o­ra­tion glob­ally. Given the gen­er­ally lower volatil­ity and reg­u­lar in­come that bonds pro­vide in­vestors, they re­main an im­por­tant part of an in­vest­ment port­fo­lio. An at­trac­tive fea­ture of bonds is the abil­ity of in­vestors to di­ver­sify. Not only can in­vestors di­ver­sify by is­suer, but they can se­lect a va­ri­ety of ma­tu­ri­ties, coupon fre­quen­cies and coupon rates. This en­ables in­vestors to have a de­gree of con­trol over port­fo­lio risk and cash- ow. Be­sides bank is­suers, there are a signi cant num­ber of other is­suers pro­vid­ing ex­po­sure to other cor­po­rate sec­tors in­clud­ing ru­ral, food and elec­tric­ity. Bond port­fo­lios need to be struc­tured to pro­vide a healthy cur­rent yield but also pro­tec­tion against ris­ing in­ter­est rates. An Au­tho­rised Fi­nan­cial Ad­viser is able to pro­vide you with ad­vice about how best to use bonds as a key com­po­nent of your in­vest­ment mix. The key risk mea­sure­ment for a bond port­fo­lio is du­ra­tion which is stated in years. In­vestors can use du­ra­tion to mea­sure the volatil­ity of a bond. Gen­er­ally the higher the du­ra­tion (the longer an in­vestor needs to wait for the bulk of the pay­ments – in­ter­est and prin­ci­pal) the more its price may move as in­ter­est rates move ei­ther up or down. Fi­nally many in­vestors are con­tent with term de­posits as the xed in­ter­est com­po­nent of their in­vest­ment port­fo­lio or in some cases as the only com­po­nent of their in­vest­ment port­fo­lios. Term de­posits can pro­vide at­trac­tive re­turns and we saw that in the high in­ter­est rate en­vi­ron­ment pre­ced­ing the Global Fi­nan­cial Cri­sis. While term de­posits do rank equally with se­nior bonds, they do not of­fer all of the di­versi cation bene ts of a bond port­fo­lio, as de­scribed above. Ac­cord­ing to the web­site www.in­ter­est.co.nz, the av­er­age three year bank term de­posit rate has fallen from 6% in Au­gust 2010 to 4.85% in July 2012. This year, the av­er­age term de­posit has fallen to 4.4%. This means that in­vestors who placed $100,000 into three-year term de­posits in late 2010 may, for ex­am­ple, have their in­come re­duce by al­most one fth when their de­posits ma­ture. Se­lected bond in­vest­ments may of­fer such in­vestors a pos­si­ble al­ter­na­tive. While in­vest­ing in bonds is not with­out risk, they continue to be an im­por­tant means of achiev­ing in­vest­ment port­fo­lio di­versi cation in achiev­ing your in­vest­ment goals.

John Sher­son In­vest­ment Ad­vi­sor, Forsyth Barr Michelle Rol­ley In­vest­ment Ad­vi­sor,

Forsyth Barr

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