WHAT SHOULD I INVEST MY FIXED INTEREST IN?

Now that two finance companies have gone into receivership, we have had some readers ask us, “what fixed interest should they invest in?” While this may seem to be a straight forward question, there are a number of areas to consider.  Experience shows that people invest in fixed interest primarily because of the regular income that these investments can provide.  How much income do you need, and how much investment risk are you prepared to take are two important considerations.

Whilst two finance companies over the past six weeks have gone into receivership, this does not mean that all finance companies are bad and not worth investing in.  There are a few out there that are probably a disaster waiting to happen.  There are a few stand out performers which we are prepared to recommend to clients.  That then leaves the vast majority who rely on their newspaper advertising to attract investors.  Most will use what appears to be an attractive interest rate to lure investors.  Some may offer low rates to give the impression of being especially secure.

A relatively low risk option is to invest in mortgage trusts.  Unfortunately the past returns you see are invariably after tax returns at 33%.  Numerically these will invariably appear somewhat lower than bank deposit rates.  The returns will vary depending on prevailing mortgage rates.  One that is based on floating rate mortgages will fluctuate more than one where most of the lending is on fixed rate mortgages.  The returns and security of the investment will be strongly influenced by the lending policies.  Mortgage trusts that have a high percentage of lending to property developers may offer higher returns to investors; however they may have a higher level of loans in arrears. 

One of the recent trends has been for some investment providers to establish mortgage funds, and have finance companies procure the mortgages for the fund.  The mortgages are insured, and must comply with stringent parameters concerning loan to valuation rates, maturities etc.  These mortgage funds can then provide attractive known investment returns with a lower level of investment risk, than for example investing in a secured debenture.

There is always the opportunity to invest in direct fixed interest via tradeable securities on the stock exchange.  There is a cost to do so, and the capital security of the investment is subject to market volatility.  Some of these investments are rated by agencies such as Standard and Poors.

Popular forms of fixed interest over the past few years have been collatarised debt obligations.  A Collateralised Debt Obligation (CDO) is a special-purpose company that raises financing in the public debt markets, and invests the proceeds in portfolios of debt.  A CDO is also very similar to other asset-backed securities (such as a mortgage trust), but it has various levels of 'seniority' built into the debt structure, so an investor can vary the amount of risk and reward they are exposed to.  These are difficult investments to understand, but they can be a useful fixed interest component for a small portion of an investor’s portfolio.

Of course, if an investor wants real security, they may consider simply staying in cash or using a bank deposit.  The catch here is that the banks have differing credit ratings.  You may also find for the Australian owned banks that their Australian customers rank ahead of their New Zealand customers.