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Lower Bond Rates May be Here to Stay

Most people with money to invest tend to look at fixed interest investments as a home for some of it. Traditionally fixed interest is used within portfolios for stability, a means of reducing overall investment risk, and as an income stream.

Historically this tended to work out most of the time. Traditional correlations between bonds and shares only had around a 5% chance of negative returns occurring around the same time. Unfortunately, a lot of investors in the early 1990’s got caught out by this one in nineteen-year event, and made significant losses.

New Zealand and Australian bonds have historically offered higher coupon rates (interest rates) than American ones. One of the reasons is because of the exchange rate risk, relative to the USD. This premium was typically 3 to 4% higher than the US rates, giving an Old Normal rate for ten-year Australian Government Bonds of 5 to 6.25%. Since the 2008 Global Financial Crisis the rates have been a lot lower, and may well be like that for many years to come.

The Lower for Longer regime shown, is a massive 2.25% below the Old Normal. This will have implications on what we should expect to pay for shares and property. The amount below the “old-normal” is close to the target inflation rates that the New Zealand and Australian Reserve Banks are unsuccessfully targeting.

What is this going to mean for investors? They should not expect to receive interest rates several percent higher than the inflation rate. Tax rates are lower than they were historically. Even at the lower interest rates the after-tax returns are higher than the inflation rate.

Provided the market does not over react, dividends should remain attractive and be a strong building block for the total return that well selected shares can offer. Advisers and investors alike will need to focus and decide what returns are required, and not take unnecessary risks by chasing unrealistically high returns.

Disclaimer

Steven Barton (FSP 32663) and Susan Pascoe Barton (FSP 32382) are Certified Financial Planners and Authorised Financial Advisers.  Their initial disclosure statements are available free of charge by contacting them on (07) 3060080 or they can be downloaded from www.pascoebarton.co.nz. This column is general in nature and should not be regarded as personalised investment advice.