Fixed income investment
21 Nov 2012
Fixed income investments may offer predictability for retirees. But there are risks. Should you invest in them?
After the volatility and plummeting investment returns of the global financial crisis, many retirees, looking for more certainty and stability, are turning to fixed income investments – term deposits, government bonds and corporate bonds – which guarantee payments on fixed dates and tend to be less volatile than equities.
“Investors increasingly concerned about instability in equity markets and its effect on cash flow requirements are shifting to bonds,” says Andrew Gordon, director of fixed income broker FIIG Securities.
Term deposits have been the most popular fixed income instrument in recent times, but their rates are now falling and, with yields on government bonds also anaemic, corporate bonds are becoming more attractive. Generally, investors enjoy higher yields, greater transparency, no fees and buying direct, allowing better cash flow management.
“Direct bonds provide investors with the ability to lock in returns for years to come without ongoing fees,” Gordon explains.
Get defensive
Fixed income assets have long provided a strong defensive element in retirees’ portfolios; bonds usually zig when the stock market zags.
When the GFC shattered investors’ belief in equities, many advisers urged Australians to boost their fixed income holdings. Many retirees had already done that, investing in term deposits – the Federal Government had guaranteed them and they were providing attractive yields.
But with interest rates falling, yields on term deposits are also declining.
The safest fixed income assets are Australian Government bonds – one of the few remaining AAA-rated bonds. But this safety has a downside: yields are historically low due to their safe-haven status and strong demand from international investors.
In this environment, corporate bonds, issued by Australian companies such as Telstra, have become extremely attractive for retirees. Assuming the corporate bonds are held to maturity, a total return around the 7 per cent mark can be achieved, against 5.5 per cent to six per cent, at best, for term deposits.
Smaller investments
Corporate bonds have traditionally been the preserve of the big end of town and investment funds; in the past, investors needed $500,000 to buy a bond. For the average investor or retiree, that meant too much exposure to a single bond and a lack of portfolio diversification.
Recently, however, brokers such as FIIG have broken down bonds into $50,000 parcels, small enough to allow ‘direct’ ownership, rather than ownership through a managed fund.
Why would a retiree own a corporate bond directly? There are two major benefits: firstly, they’re more transparent. It is easy for an investor to analyse and monitor one company, rather than the dozens typically held in a managed fund.
The other benefit is managing cash flow, which is particularly important for retirees. Distributions from managed funds are not as predictable as direct bond holdings. But retirees can use direct bonds with staggered maturity dates (maturity is when the bond investment is paid back), to match cash flow needs.
One strategy some retirees are using is to put their next six to 12 months of cash flow needs in term deposits, then invest their cash flow needs for the next two to five years in corporate bonds.
FIIG’s Gordon said a fixed income portfolio might include leading corporate names such as Telstra, Wesfarmers, Sydney Airport, Leighton, Envestra and Downer. Those bonds are available in investment lots of between $50,000 and $100,000, and yields range from approximately 6 per cent to 8.5 per cent per annum.
“On top of that, there are a number of banks that can be added to the portfolio as well for additional diversification,” Gordon said.
Corporate bonds, however, are not an entirely free lunch. “There is the opportunity for greater returns in corporate bonds but there is also more volatility and more risk,” Gordon said.
There are also some benefits of holding bonds in managed funds. “In volatile times fund managers earn their money through managing the risk of your portfolio in order to achieve capital growth and not just yield,” said Andrew Heaven, a financial planner at WealthPartners Financial Solutions. But he adds that you pay for that expertise through fees, which are not charged on direct bond holdings.
One area many advisers advocate investing in via managed funds are international bonds, due to their greater complexity and risk, including exchange rate risk.
How much to invest
Once they have decided on an appropriate fixed income asset, a major consideration for retirees is how much of their portfolio to allocate to fixed income. “It depends on your age, your risk profile and your income needs,” Financial Planner Andrew Heaven says. “One thing I will say is that for retirees the focus shifts from capital growth to capital protection and therefore bonds and fixed interest investments can play a vital role in a retiree’s portfolio.”
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