It’s almost hard to remember but there was once a time where fixed interest investments (term deposits and bonds) were a sure-fire bet when it came to investing. Back in June 2008, six-month term deposit rates were offering average weighted returns of 8.45% in Aotearoa, a far cry from the 0.83% offered for term deposits in December 2020.
More recently, central banks across the world have slashed their short-term interest rates in the face of the Covid-19 pandemic.
This major reduction in rates has been good news for those with mortgages, but not so much for those saving and investing. You may have noticed that since the start of the year, returns in our Conservative funds have been negative, so just what is going on and how do negative returns in fixed interest happen?
A quick explainer on fixed interest investments
If you’re in a Conservative Fund with Kiwi Wealth, most of your money will be invested in fixed interest, primarily bonds. This is because fixed interest usually offers a more stable rate of return than share market investments. Some exposure to the share market is included in these funds but the primary goal of a Conservative fund is to provide modest gains over a short to medium-term timeframe.
Why am I getting negative returns?
In a word, bonds. Bear with us as the next few sections will be quite technical so we have included a link to a handy explainer by Sorted on how bonds work to help.
A bond is effectively a loan to an entity (such as a government, council or company) and that loan is paid back with an agreed interest rate. This interest forms part of your return.
A bond is also given a dollar value every day. This is because anyone who owns a bond can sell it to somebody else at any time they choose. Whether someone wants to sell a bond or not is irrelevant, it still must be valued regularly. What is happening in the market and economy directly impacts the value of bonds.
Put simply, market changes over the last few months has meant the value of some bonds Kiwi Wealth holds have decreased resulting in negative returns for our Conservative fund investors.
How can bonds lose value?
Much noise has been made about the drop in short-term interest rates in New Zealand, but long-term interest rates for bonds are actually rising. This is due to better than expected economic performance in the recovery from Covid-19, both in New Zealand and across the globe.
This means that longer term bonds issued today offer higher interest than bonds issued less recently. When it comes to valuing our bonds, those that pay back less interest are worth less than those paying higher interest. When long-term interest rates go up, new long-term bonds are worth more and old long-term bonds are worth less.
How does valuing a bond impact me?
Your balance isn’t a specific dollar amount like you would see in a bank account. Instead your balance is your share of the current value of all the investments the fund holds. When it comes time to take money out or put money in, it’s important that the bonds reflect their current value when your investment/withdrawal is processed.
How is Kiwi Wealth navigating the current market?
All fund managers are facing the same issue with bonds. Our approach to interest rate risk is to hold a wide range of bonds with different maturity dates – both short and long-term, but we’ve more recently reduced some of the long-term bonds and invested in term deposits that are not affected by the rise in interest rates.
It’s important we continue to hold a variety of bonds to protect against unforeseen economic changes such as new virus strains hurting the economic outlook.
As bonds in the fund reach their end date, we are actively reinvesting at the new higher interest rates available in the market now. So over time the average interest rate on the bonds held by the fund should go up.
It’s been a turbulent time in bond markets not only in New Zealand but around the world. The S&P/NZX Government Bond Index (essentially an average measure of performance across all NZ Government bonds) has been negative since October 2020. Kiwi Wealth’s fixed interest investments have outperformed this market benchmark over this period. What this means is that while returns have been negative for fixed interest across the board, our investment management team have made active decisions and performed well in a difficult environment.
What should I do?
There are unfortunately no investments which don’t involve an element of risk and our Conservative funds are no exception. Remember that you haven’t lost any money until you make an actual withdrawal, and when you think of your investment you should be thinking more longer term. Check out the suggested investment timeframes for our Conservative fund options for our KiwiSaver Scheme and Managed Funds.