Bond investors more clued up on returns than risks

Bonds

FMA survey finds more than 60% of bond investors know their interest rates and maturity dates, yet only 38% understand bonds aren’t guaranteed

17th Aug 17, 6:02am by Jenée Tibshraeny

It is perhaps unsurprising, but nonetheless concerning, that many bond investors know more about their expected returns than the risk of their investments.

More than 60% of Financial Markets Authority (FMA) survey respondents who have invested in bonds knew their interest rates and maturity dates.

Yet only 38% of all 505 of those surveyed between June and August were aware bonds aren’t guaranteed.

Two-thirds of survey respondents who invested in bonds said they were certain the company or government issuer would pay them back, but only 44% knew the credit rating of the bond.

Only 52% of all survey respondents, and 64% of respondents who had bought bonds, knew they were investing in a form of debt.

And only 39% of respondents knew bonds don’t keep their original value if you sell them before maturity.

A 2014 FMA survey found a majority of respondents believed New Zealand bank term deposits are guaranteed, when they aren't.

This level of financial literacy is concerning given over a million New Zealanders have more than $15 billion invested in conservative or default KiwiSaver funds, which are mostly invested in fixed interest assets, including bonds.

The FMA’s external communications and investor capability director, Paul Gregory, says: “Investing in bonds is often associated with greater certainty and lower risk, but that’s not always the case.

“We recognise in our Strategic Risk Outlook that after a long period of lower interest rates, it is inevitable they will rise again. When that happens, bond values tend to fall and there may be negative returns for conservative and default funds.

“It is important investors are not unnecessarily surprised if that happens to their bonds in those conditions. Don’t panic. Don’t sell or switch out just because you have some negative returns. Think about whether you’re still on track for your longer-term goals before making any decisions.”

Nearly 70% of those surveyed thought conservative funds are low-risk investments, almost the same as the rating for term deposits. The FMA points out this is not always true. Conservative funds contain a mix of different bonds, with different maturity dates and credit ratings, and may include some shares.

Gregory concludes: “Improve your knowledge about the risk of your investments. Reduce your potential to be surprised or take hasty action which harms your ability to achieve your goals. Do your own research about what might happen to them in different market conditions. Get some help from your provider or some professional advice.”

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9 Comments

by Foxglove. | 17th Aug 17, 8:20am 1502914835

Cannot quite recall but did not Trump fail in the 80's & leave a mountain of junk bonds rotting behind him. Only to restart in the 90's with the same tactics. Now would seem because he is the President interest in these sort of "securities" are re-igniting. Does history never teach anything & is this trend together with the debt mountain in the USA & elsewhere the pathway to another GFC. Personally would have thought NZ bonds etc easy enough to assess in terms of risk, recent failures have of course been mainly these type of issues by the finance companies, SFC, Strategic, from memory & the, shall we say, funnies or what the NZX included in the hybrid category, such as Credit Sails which are precisely examples of what this column is warning about, ie the old adage, the best return is the return of your capital.

by ACB | 17th Aug 17, 3:26pm 1502940402

Think you are confusing credit risk of high yield debt products with interest rate risk (causing mark to market losses) on much safer government debt. The FMA are basically trying to tell retail investors that you should expect losses on high quality, defensive bonds when interest rates rise (and make profits when they fall) and not get alarmed and pull your money out and take much greater risks elsewhere.

Remember a bond is just like a term deposit but it can be sold at anytime whereas a term deposit is typically held to maturity. Both have the same credit risk, term deposits have the same volatility in underlying value but because they are illiquid this volatility is not recognised by the investor (usually).

by Foxglove. | 17th Aug 17, 4:08pm 1502942913

Tks for that & noted. Actually my main thrust was really regarding actual defaults such as above examples. Appreciate yields will always fluctuate in line with interest rate movements but if the investor has an attitude to stick it out,when that may become adverse, and hold until maturity then there will at least be no loss of capital, and it will only on the difference of what might have been earned elsewhere. Of course that does not apply to perpetuals especially if the resets or whatever are pegged unfavourably.

by linklater01 | 18th Aug 17, 4:13pm 1503029603

ACB,

I am a little confused by your reply. Not all bonds have the same credit risk-going from AAA to junk bond status. You say that retail investors should expect losses on high quality defensive bonds when interest rates rise,but that is incorrect. The bond price will fall,but its maturity price will not.For high quality bonds,the investor can expect a return of capital at maturity.

by Stephen Hulme | 17th Aug 17, 1:51pm 1502934662

Moreover, capital value maybe extinguished for other obvious reasons.

The notion that elevated valuations are “justified” by low interest rates requires the assumption that future cash flows and growth rates are held constant. But any investor familiar with discounted cash flow valuation should recognize that if interest rates are lower because expected growth is also lower, the prospective return on the investment falls without any need for a valuation premium. Read more

by ACB | 17th Aug 17, 3:18pm 1502939930

The inference here is that other asset classes are overvalued unless rates stay low. And if interest rates rise then yes you will lose money on your bonds (unless you hold to maturity) but it is likely that property and more growth orientated assets such as equities will tank too since their valuations are underpinned by low interest rates.

by Stephen Hulme | 17th Aug 17, 3:27pm 1502940468

The inference with respect to bonds is the failure to generate coupon payments from the business the bonds purport to underwrite, while interest rates remain low. Hence the capital value dissipates towards zero.

by ACB | 18th Aug 17, 12:26pm 1503015973

Sure, you're talking corporate credit risk, which is most relevant to high yield bond markets but not what the FMA article was about. My point is, if you are worried about bond markets (rising interest rates) then you should more worried about higher risk investments since they all underpinned by this low interest rate environment.

by John | 17th Aug 17, 5:31pm 1502947891

How man people know that bank deposits are not guaranteed and what OBR means?