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Why Fixed Interest?

New Zealand fixed interest investments should be regarded by New Zealand investors as being the safest asset class in this country to invest in. It shouldn’t be seen as a means to “get rich quick” or a way to seek the highest yield in the market; but rather as a mechanism to provide solid, stable, regular income and retain wealth over the short, medium and long term.

 Some of the benefits of New Zealand fixed interest investments include:
  • As an asset class it allows for a high level of capital preservation providing investors maintain a quality bias and do not chase higher yield via higher credit risk securities.
  • It provides for a consistent and predictable income stream with little volatility when funds are diversified across various maturities.
  • It compliments other asset classes by providing diversification that preserves capital and provides for consistent returns.
  • It is generally an easy concept to understand with investors – money in; receive a fixed return at a specified interest rate; receive money back at maturity.
  • Funds can be invested over the short, medium and long term. 
  • Interest options can vary across different securities and offer variations of monthly; quarterly, half - yearly or annual interest periods. As well some securities offer compounding interest and interest at maturity alternatives.
  • Fixed interest investment can be as simple as a bank term deposit or be more sophisticated through the utilisation of bond investment.
  • A number of fixed interest securities can be sold prior to maturity if capital is required back earlier than anticipated by an investor. Many fixed interest securities (in particular bank and corporate fixed rate bonds) are traded after primary issuance in a secondary market. When selling securities prior to a maturity date, if market interest rates have increased from the time of purchase to the sale date, a capital loss will be incurred (calculated on the term left to run to maturity date). However, if market interest rates have reduced from the time of purchase to the time of sale, a capital gain is received. 
  • Quality fixed interest securities, in the majority of cases, are rated by a major credit rating agency (e.g. Standard and Poors) which provides for an independent indication (however not a guarantee!) as to the underlying quality of the credit risk.  Many investors spread and tier their investment portfolios based on the credit rating scales; e.g. 40% “AA” rated or higher; 40% “A” rated and 20% “BBB” rated.
  • An interest rate quoted for a new fixed interest security offering (primary issuance) or the rate quoted on the secondary market for an existing security, is made up of two key components:-

 - Underlying market base interest rates e.g. NZ Government Bond or bank swap fixed rate for a specified term.

-  Plus: the “credit spread” or “credit margin” which differs for each security depending on its credit rating, term and liquidity (issuance size and level of secondary market trading); e.g. An “A” rated corporate bond is issued at 1.75% above the five-year swap rate (market base rate).

  • Some fixed interest securities offered in the marketplace are “Subordinated” or “Capital Notes” or “Preference Shares” i.e. in the event of the issuer (bank or company) going bust, the investor holding a subordinated security ranks behind senior debt holders (bank lenders and mortgage/debenture holders) when it comes to selling assets to get their money back. Generally, subordinated securities should be re-rated two notches downwards on the credit rating scales before selection against a minimum credit rating limit. i.e. A company credit-rated A+ for senior bonds, should have their subordinated bonds regarded as a “BBB” equivalent. Subordinated bonds are therefore issued at an extra credit margin over and above senior bonds, to reward the investor for the second-ranking security position.
  • New Zealand fixed interest returns have performed consistently well relative to other asset classes over the past 20 years.
  • New Zealand fixed interest rates are generally higher than what are offered in offshore fixed interest markets. The main reason for this includes the relatively volatile nature of our economy and the perceived risk premium offshore investors require as compensation for investing in New Zealand.
  • Fixed interest portfolios needn’t be professionally managed and therefore with structure, discipline and good advice they can be monitored and maintained at a low cost. Registries now even provide a service (for a small fee) whereby they collate end of year tax information on an investor’s bond securities.
Like with any investment there are of course negatives associated with fixed interest securities as well and they include:
  • The risk that inflation can potentially undermine the long term return from fixed interest investment
  • Bond investments can lose value during their life should interest rates rise. However, providing a bond investment is held for its full term the capital value will return to “par” at maturity.
  • The opportunity cost of investing in longer dated securities in a rising interest rate environment.