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Friday, 25 March 2011 18:04

Fixed Interest Investors – Wealth Hazard Ahead

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APRA News Article for October 2010 edition

With investment markets uncertain, many investors have sought the fixed interest markets as a safe haven.  While term deposits and cash management trusts can generally be considered safe, particularly with the current Government bank guarantee, this article examines fixed interest investments that are often held in managed funds and allocated pension/superannuation funds that could actually lose money in a rising interest rate environment.

The fixed interest funds we are referring to here are usually called “Fixed Interest” or “Capital Stable” funds and form part of the investment menu of managed funds, allocated pension funds and superannuation funds.

But how can it be that a fixed interest fund can lose value?  The underlying investments of a fixed interest fund typically include long dated Government Bonds.  In Australia the Government currently issues 10 year bonds.  If an investor purchased a Government Bond and held it until it matured in 10 years time, then the investor would receive their capital back at maturity assuming that the Government was not insolvent.  So far, so good.

Fixed Interest funds usually (or should) price their investments daily and it is with this point in mind, that investors in these funds can lose value in a rising interest rate environment.  To highlight this point, consider an investor who purchased a 10 year bond for $100,000 with an interest rate of 5%.  The investor receives $5,000 of interest each year.  Should interest rates move up to 10%, the investor would only require $50,000 of capital to generate the same level of income.  When fixed interest investments are valued daily, it is this logic that is used to determine the current value of a bond.  The principle is simple, fixed interest investments can increase in value when interest rates fall, and can lose value when interest rates rise.

Information sourced from Eurostat, International Monetary Fund and Bloomberg show that forecast annual Government Budget deficits around the world for 2010 – 2012 will be around USD $8 trillion (assuming budget balances are converted into US Dollars using the exchange rate on 12th May 2010).  The IMF has forecast in its Economic Outlook in April 2010 that these deficits are to be financed by a limited pool of savings.  The IMF forecast that the combined global current account surplus positions for 2010 – 2012 are around USD $3.8 trillion.  This means that it is forecast that governments around the world will require $8 trillion of funding over the next 3 years, but the savings pool is forecast to be less than half that.

This can only result in competition for debt from Governments around the world and the simple forces of supply and demand tells us that this can only lead to increases in interest rates.

Linking back to the effect of rising interest rates on fixed interest investments, below is a chart prepared by Magellan Financial Group showing the loss of value of Government Bonds assuming a rise in long term interest rates of 2% and then by 4%.  You will see that the value of an Australian 10 Year Government Bond would drop by 24.9% in the event of long interest rates rising by 4% (light blue bar), and would fall in value by 13.6% if long term rates increased by 2% (mid blue bar).

 

The message here is clear, Government debt around the world exceeds available savings and is extremely likely to put upward pressure on long term interest rates.  Investors should assess the impact of rising long term interest rates on any fixed interest investments they hold as a matter of urgency.

Author of this article is Mark Draper, from GEM Capital Financial Advice.  Further investment knowledge is available on the GEM Capital website – www.gemcapital.com.au.

For those wanting to complete presentation from Magellan Financial Group about the issue of rising long term interest rates, please either ring (08) 8273 3222 or email your request to This email address is being protected from spambots. You need JavaScript enabled to view it.

Last Friday’s earthquake in Japan has bought massive human misery. It will also have economic consequences for the global economy as well as Australian Companies.
Here is our first pass at identifying some industries and companies that are likely to be impacted in some way (either positively or negatively).

Insurance Companies
Insurance risk modelling group AIR Worldwide estimates that the total insured losses could be up to US$34.5bn excluding tsunami damage. QBE updated the market yesterday with a preliminary estimate that claims from the earthquake and tsunami would be around US$125 million, which is not financially significant to QBE. Other Australian insurers are not likely to have any exposure to this event.

Uranium Miners
The market is questioning the future strategy of nuclear energy following the threat of meltdown of several nuclear reactors. We have no exposure to uranium miners at GEM Capital and do not recommend pursuing this area.

Australian Inbound Tourism
Japanese and New Zealand tourists make up a large volume of inbound tourism to Australia. Listed companies that could be negatively impacted by earthquakes in both countries include Tabcorp (hotels and casino’s), Qantas and Virgin Blue. GEM Capital has very little exposure both directly and via managed funds to these sectors.

Japanese Property Groups
GEM Capital has no exposure to listed Japanese Property Companies which include Astro Japan Property Group and Galileo Japan Trust. In any case, both of these companies have stated that their properties were not significantly impacted.

Potential Beneficiaries
Australia’s coal industry and Liquefied Natural Gas producers could be a beneficiary if increased demand for these sources of energy over nuclear eventuates. Coal industry could suffer from a proposed carbon tax. Origin Energy has exposure to energy and in particular LNG.
Suppliers of construction materials, such as steel and concrete. This is likely to be short term in nature though.
We will provide a further update of this information on our website as we develop our thoughts and gather additional information, particularly to do with the banking system.
At this stage however we stress that this event does not alter our fundamental view of investments as it is likely that most of the impacts from an investment perspective (rather than human perspective) will be at the margin.
I trust that you have found this information useful.

Kind Regards
Mark Draper CFP, Dip FP
Authorised Representative

Monday, 17 February 2014 11:47

US Recovery – It’s real!

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There continues to be much skepticism among the general public about the recovery of the US economy.

US-4-Budget-Position

In this article, we provide a series of charts that show that the US recovery is very real.

Further evidence can be seen in the US share market.  During the most recent company reporting season we saw 68% of companies in the S & P 500 beating earnings expectations.

The next chart shows the average monthly employment growth – note that a number of 200,000 new jobs is required to lower the unemployment rate.

US-2-Employment-Growth

The US Housing market has a multiplier effect throughout the economy both in terms of employment as well as consumer spending.  Activity and prices have most certainly turned as can be seen in the chart below.

US-3-Housing-Market-Recovery

The US Budget position has dramatically improved as economic activity has turned.

US Corporates are also in good shape – earnings have beaten expectations and their balance sheets are in good shape.

US-4-Budget-Position

DISCLAIMER: The above information is commentary only (i.e. our general thoughts).  It is not intended to be, nor should it be construed as, investment advice.  To the extent permitted by law, no liability is accepted for any loss or damage as a result of any reliance on this information.  Before making any investment decision you need to consider (with your financial adviser) your particular investment needs, objectives and circumstances.

This entry was posted in Debt Crisis, Investment Advice, Self Managed Superannuation, Superannuation and tagged , , , by Mark Draper. Bookmark the permalink.

Monday, 17 February 2014 11:47

CSL – Company Update – January 2014

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CSL has long been a company we have liked.

Mark Draper (GEM Capital) talks with Daniel Moore (Investors Mutual) about some recent developments with the company as well as an important accounting measure that investors should be aware of when valuing CSL.

DISCLAIMER: The above information is commentary only (i.e. our general thoughts).  It is not intended to be, nor should it be construed as, investment advice.  To the extent permitted by law, no liability is accepted for any loss or damage as a result of any reliance on this information.  Before making any investment decision you need to consider (with your financial adviser) your particular investment needs, objectives and circumstances.

 

This entry was posted in Investment Advice, Self Managed Superannuation, Shares and tagged , , , , by Mark Draper. Bookmark the permalink.

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