Investing in Bonds
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.