Time to revisit fixed income
Written and accurate as at: Feb 03, 2016 Current Stats & Facts
Link to Video
Video: Morningstar's Christine St Anne and David Simon
Video Transcript
Christine St Anne: With interest rates easing in Australia, term deposits may no longer be attractive. Other asset classes, however, could add value. Today, I am joined by Westpac's David Simon to explore the case for fixed interest. David, welcome.
David Simon: Thank you, Christine.
St Anne: David with interest rates easing, how does that impact fixed interest?
Simon: Fixed interest assets tend to have a different relationship to falling interest rates. In fact, generally speaking, fixed interest assets actually can appreciate in value when cash interest rates are actually reducing. The premise behind that is that the actual bond itself is paying a higher rate than what the market is paying in terms of cash due to the reducing interest rates, hence increasing the - potentially increasing the value of the bond itself.
St. Anne: So what kind of fixed interest assets can investors look at?
Simon: Fixed interest is an asset class that is effectively where an issuing company is looking to raise funds. Now it doesn't have to be just a company, it can be a government in all the different forms such as state, federal, commonwealth and indeed even local government. And indeed companies and financial institutions, such as even banks that are looking to raise capital can issue fixed interest notes.
So fixed interest notes come in the form of government bonds, corporate bonds as well as other types of assets such as debentures and indeed hybrid securities, which exhibits features and characteristics that mirror both equities and fixed income alike.
St. Anne: David, how can they access those bonds, perhaps, through managed funds?
Simon: Yeah, look investors have the ability to access fixed interest assets in various different forms. They can access fixed interest assets through a managed fund and a managed fund is typically a basket of a series of bonds in which the fund manager would actively purchase and sell and trade -- there is also an aspect where you can buy bonds directly.
So, you can go to a issuing company, such as even a bank that maybe offering a hybrid note and investors could access that directly either at the initial offer or indeed via the ASX as they regularly trade on a daily basis.
There are also other instruments such as direct corporate bonds and indeed even immediately had to be released with asset has really encouraged the Commonwealth to actually offer retail investors with Australian government bonds as well, so there are different, various forms and indeed even exchange-traded funds that are effectively bond as well which effectively track an index with bonds.
St. Anne: David you measured the fixed interest exchange-traded funds or ETFs. These products are relatively new. What are your views on those ETFs?
Simon: The rationale between fixed interest ETFs is effectively to track a particular index. My view is it's particularly difficult to track an index like a bond index because the bond market is significantly large and it's quite difficult for an exchange-traded fund to have access to all those individual securities alike.
So, what we're finding is there is some type of tracking error and tracking error is effectively the disparity between the actual ETF itself and the underlying benchmark they are looking to follow. So that is certainly something that investors should be aware of when moving into these exchange-traded funds.
Some of the benefits are certainly around diversification, so nonetheless even though there maybe some tracking error, it's easily purchased via the ASX where you have an underlying exposure to a series of bonds and that gives you diversification just by having that ETF.
Other things such as cost is also quite attractive, so by accessing ETFs, they are typically and relatively lower in terms of ongoing fees, meaning there is more income for the investor rather than fees that they are paying.
Other aspects such as flexibility around the fact that if an investor wants to access money from their ETF, they can quite easily trade that on the ASX and sell their holdings, it's not something that you wouldn't be able to do via a term deposit without penalties.
St. Anne: David, a lot of people look at cash as some form of fixed interest asset, is it safe just to remain in cash?
Simon: Yeah, look, Christine, it's a really good question you ask. I mean, cash is a very important asset class, especially someone who is investing for the short term. So, it may go up maybe even two years, cash is a reliable form of investment because it's liquid and it's secure. However, beyond that you start really feeling the impacts of the after-tax and after inflationary impacts of cash. where you find that once you account for those two factors, you're actually going backwards.
So, that's why it's important for investors to, obviously based on their personal needs, objectives, investment timeframe, their appetite toward risk, their ideology around investments overall, to look at alternatives to cash around that medium-to-long term. Fixed interest could be one component that would fit nicely within a really well-diversified quality portfolio.
St. Anne: David, thanks for your views today.
Simon: Okay, thank you, Christine.