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 Financial Happenings Blog 
Wednesday, January 28 2009
In the current climate of downward pressure on interest rates the attractiveness of holding cash is fast losing its luster.  Last edition we looked at the benefit of Australian shares and the income they produce over time and the compelling argument behind continuing to hold those investments in portfolios.  Unfortunately the down side of growth assets such as Australian shares is that their asset price is volatile over the short to medium term.  2008 has provided a stark reminder of this.  So it does continue to make sense to hold defensive assets like cash and fixed interest to smooth out this volatility and also to provide assets that can be drawn down on if required knowing that you will not be drawing down on these assets at low prices.

 

But is there a better alternative to cash in the present climate that still provides a low volatility exposure?

 

The answer to this question is yes, if managed well, through using fixed interest investments.  To first provide some anecdotal evidence, the high quality fixed interest trust we suggest to clients has returned 2.82% over the past 3 months to the end of December 2008 as compared to 1.69% for a relevant cash index - UBS Warburg 90-Day Bank Bill Index.

 

Why this is so goes to the rules of how fixed interest investments, commonly referred to as bonds, are priced.  In times of falling interest rates, bond prices should rise all else being equal.  This is because holders of the bond are promised a fixed rate of return for providing that debt to the government or a company.  As interest rates in the economy fall, the rate receivable on these bonds become more attractive, therefore prices adjust to reflect this attractiveness and returns improve.

 

This is a very simple explanation and more detail should be considered before jumping into fixed interest investments.

 

The following is an extract from our book - A Clear Direction - Your Guide to Being a Successful CEO of Your Life which we hope provides more detail around the topic of holding fixed interest.

 

Fixed interest securities are traditionally loans made by investors to governments or companies.  These types of securities represent a loan to the issuer usually in return for periodic fixed interest payments.  These payments continue until the security is redeemed by the issuer at maturity or earlier if called.  Under law, holders of debt have the first call on the income and assets of a company.  Specifically interest payments have priority over any dividend payments to shareholders.  As a consequence such investments are generally viewed as less risky than equity investments because holders must be paid first before any returns are paid to shareholders.  However, fixed interest securities are not risk-free and may carry many different kinds of risk.  As a result these investments are riskier than holding cash.

 

We would therefore expect, over time, that the expected returns on fixed interest securities would be less than returns to owners of shares in a company but more than simply leaving cash in the bank.

 

Use of these types of securities sounds simple.  However there is much more to the story.

 

Rather than include the whole chapter within this blog we have included a copy on our website: Fixed Interest Investments

 

Regards,

Scott Keefer

Posted by: Scott Keefer AT 07:09 pm   |  Permalink   |  Email
 
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