Tuesday 08 March 2016 by FIIG Securities FIIG Securities Opinion

Protecting your portfolio against interest rate changes

Published in The Australian 8 March 2016

The latest RBA cash rate decision met market expectations but analysts are split on their future direction. This article examines how investors can protect themselves no matter what happens to rates

The latest RBA cash rate decision met market expectations but split analyst outlooks on future expectations.

Your interest rate views impact how and what you invest in, so interest rate movements really matter. I’m frequently asked my view on the perennial debate between investing in fixed versus floating rate investments. With analysts divided on the future cash rate, they are worth discussing.

The global economic data available does not show sufficient evidence of the growth needed for central banks to raise interest rates.

Sure there are green shoots in the US and it has made a single attempt at raising rates from its zero base but analysts are split on whether we’ll see further rises in 2016. Consider negative interest rates in Europe and Japan and conflicting Chinese data, much of which indicates slowing markets. In most countries, inflation is simply too low to contemplate interest rate rises.

Australian GDP figures bucked the trend last week with higher than anticipated growth which was a positive sign, as are rallying commodity prices.

However, it’s going to take more than one set of better than expected growth figures for the RBA to increase the cash rate. Any rate rise would see a further influx of foreign investment and push the dollar even higher. Caution will be the catch-cry.

Whatever the next RBA move, it is likely to be a long, slow road ahead.

To my mind, the risk from here is to the downside that is of official rates dropping further.

If your primary strategy is investing for income, I still think you want to be protecting against a further decline in interest rates. Fixed rate investments such as deposits, government and corporate bonds should be considered.

The Qantas fixed rate bonds maturing in 2020, 2021 and 2022 have been long favoured. They pay interest of between 4.4 per cent and 4.8 percent per annum and these are attractive rates in this environment.

Aside from Qantas, two other attractive over the counter, fixed rate higher yield options are New Zealand Insurer, CBL offering 6 per cent per annum maturing in April 2019 and property company 360 Capital maturing September 2019 offering 6.1 per cent per annum.

There are longer dated fixed rate bonds for those worried low interest rates are going to be prevalent for a long time. Queensland Treasury Corporation has a fixed rate bond maturing in 2033 that has a yield to maturity of 3.3 per cent per annum, which is low, but comparatively, a good step up from term deposit rates. While long dated, the bond is very liquid.

One favoured USD trade has been to invest in very long dated Newcrest 2041 bonds with a current yield to maturity of 6.97 per cent per annum. This is a higher risk trade given the term and potential swings in currency but a useful hedge if you think we are in a low interest rate environment for a very long time.

Fixed rate bonds will give you absolute certainty over income and return capital at maturity. You can then limit the downside risk to your income, which I think is crucial for SMSFs.

If you are not reliant on the income from your investments there are some very good floating rate margins being offered, to the point where I’m almost indifferent between investing in fixed and floating investments.

Two suggested floating rate bonds are Dalrymple Bay Coal Terminal maturing in June 2021 with a projected yield to maturity of 4.85 per cent per annum and childcare provider, G8 Education at 6 per cent per annum. These returns are estimated using forward expectations of interest rates and may go up or down.

How you structure your portfolio really comes down to your interest rate views and ultimate goals.

I think it’s a useful exercise to assess the downside risk. That way you can structure it to cater for those possibilities as opposed to being shocked if they eventuate.

All the bonds except the Newcrest 2041s are available to all investors from $10,000 per bond, with a minimum initial investment of $50,000. The Newcrest bond is only available to sophisticated or wholesale investors.