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Fixed Income Update

FIXED INTEREST AN ESSENTIAL BUFFER FOR PORTFOLIOS.

 

By Grant Davies, Investment Adviser.


Including Fixed Interest in an investment portfolio helps to reduce your risk, and will help protect your portfolio in a market downturn. Having quality fixed interest is essential, which is why the Hamilton Hindin Greene’s Investment Committee guidelines specify that at least 20% of the fixed interest portfolio should be rated A- or above by Standard & Poor’s.

This is a high bar, particularly when we consider the interest rates on offer for fixed interest that is rated A- or above. The table below shows  the yield to maturity for a range of A- or above fixed interest instruments.

 

Risk vs. Return is a constant discussion  point at Hamilton Hindin Greene, and discussions with clients have often lead to the conclusion that the returns on offer in the table above are not sufficient. For this reason we will often focus our fixed interest recommendations on high quality BBB rated, or even unrated bonds. The returns available in this space are superior to that in the A- or above category. We reduce the risk by selecting companies that we consider to be ‘blue chip’ in nature, with conservative balance sheets, strong cash flows, and a solid earnings history.

We reduce  this risk further by recommending clients have a well-diversified portfolio. This means owning bonds  issued  by different companies, operating in different sector’s  of the economy.  Well diversified should also mean having different maturity dates.
We recommend a well laddered  fixed interest portfolio as shown below. This means having bonds  that mature at varying dates, and oftenincluding bonds where the interest rate resets on an annual basis.
The reason  we ‘ladder’ a fixed interest portfolio is to decrease your ‘interest rate risk’. This is the risk that interest rates are low at the point in time when your fixed interest instrument matures. If you have a lumpy fixed interest profile, with a large chunk maturing at one point in time, you would be stuck accepting whatever rates are available when that ‘chunk’ matures. We ladder your maturity profile to lessen this risk. 


TERM DEPOSITS VS TESTED FIXED INTEREST

The other advantage of laddering is the added liquidity should you require funds in the future, you will always have a bond within reach of maturity. This is something  that those  of you with term deposits should also consider,  particularly given the difficulties with breaking term deposits these  days. The Reserve Bank of New Zealand Open Bank Resolution policy has not only put term deposits on the table in the eventof a bank going into default, it has also made term deposits harder to break (usually a stand-down period of 31 days is required). This is another advantage of listed bonds, the funds are available within 2 business days of the sale. 

 

 

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