In their latest Investment Insight NZ Funds discuss a problem that has been concerning me for a long while.
Fixed interest securities, such as bonds, have an important role in the portfolios of clients with a low tolerance to risk or a short time-horizon. They provide low risk and a steady interest income throughout the life of the security.
In recent years the returns from fixed-interest securities have been supported by declining interest rates, as their value is inversely related to the level of interest rates. In a falling interest rate environment, their value has been increasing. This has provided support to the returns provided by conservative funds.
Now we are in a rising interest rate environment their value is going to be eroded. This is going to be a challenge for low-risk funds and will even act as a drag on balanced funds.
Mark notes that the New Zealand Corporate Bond Index has returned -4.3% for the year to date (21 October), while the New Zealand Government Bond Index has generated -6.8%.
In this context, Term Deposits and Savings Accounts are looking like a favourable option. Mark discusses how NZ Funds are meeting the challenge. This includes their Income Generator fund launched last year; where necessary switching to cash; and using tools that have a short interest rate position to profit from rising interest rates.