Cash vs. fixed interest as asset classes

village idiot said:

did you say your fund was an industry fund? cant imagine a retail fund charging only 0.05% of anything.

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Yes it is an industry fund. The thing is that a Super Manager can't really stuff up a cash investment and has it's set of rules for fixed interest (like must follow an index). In this case I refuse to pay anymore in fees to anyone than what I have too. I just checked the website again, I only actually pay .04% management fees plus a $52 per year admin fee. So for say a 100k balance I only pay $92 per year in fees. Evidence and link attached.
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http://www.firststatesuper.com.au/TalkingSuper/AdditionalFeeExplanation
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village idiot said:

why would an individual ever buy a govt bond which pays 4% v a saving account which pays 6% and is backed by the same govt?

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Generally speaking an individual wouldn't unless they were particularly affluent. Essentially institutions and VHNWI (Very High Net Worth Individuals >$10m) use bonds. The reasons being:

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  The Government Guarantee applies to $250k per institution per customer. So if you have say $5m that you want in deposits, you'd need to have that money split across 20 institutions - that's a lot of paperwork and record management. Doable for sure, but what happens if you are a managed fund and have to deposit $10m or $20m? that's 40 or 80 institutions respectively - are there even that many in Australia covered by the scheme?
  

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  The total income a bond generates is fixed over the life of the bond (like a term deposit) therefore you are not subjected to fluctuations in interest rates like at-call deposits are - in addition, bonds are generally struck with long-term maturities so you've effectively 'locked in' your return - something that an at-call deposit can't do. Generally speaking, bonds will have a higher rate of return than term deposits (not always of course).

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  Can be an advantage/disadvantage: Bonds have scope for capital appreciation or depreciation. Also, bonds are very liquid.

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  In the event of some sort of disaster/collapse, bond holders receive their money before shareholders and depositors. Therefore, if I have bonds with 40 institutions i'm relatively assured that i'll get 100% of my capital back in the event of any of those institutions collapsing. Whereas with an at-call deposit or term deposit I must wait for the ATO, bond holders, share holders and other creditors to receive their investments before I have a return of my capital as a depositor. The more institutions I have deposits with, the greater my risk of not getting my capital back (as more institutions = more points of potential failure/collapse)

Essentially it boils down to just how much money you are intending to place in fixed income and how well protected you want that deposit to be.

bill, those are stonkingly low fees compared to what i've seen, and i see it is in fact open to everyone. Shame they only deal in super and dont offer the same managed funds outside of super

thanks KJM

I am wondering if another benefit of bonds is that after buying a bond , if rates fall and bonds rise, you have a profit if you want to take it, if rates rise and bonds fall, you can hold till maturity and get the original amount of capital expected back (although you would be now making less return than the market rates, capital is preserved). This is effectively an option on bond prices which has to have some value, which you could add to the total theoretical expected return?

village idiot said:

bill, those are stonkingly low fees compared to what i've seen, and i see it is in fact open to everyone. Shame they only deal in super and dont offer the same managed funds outside of super.

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Low fees alone are not necessarily a good thing, the real figure to look at is return net of fees.. If I am getting above market return what does it matter if the fund charges 2% to employ the best people to achieve the best returns??

Same can be said for SMSF, people tent to forget about the Accounting and Admin fees and the cost of your own time when looking at returns..

I am wondering if another benefit of bonds is that after buying a bond , if rates fall and bonds rise, you have a profit if you want to take it, if rates rise and bonds fall, you can hold till maturity and get the original amount of capital expected back (although you would be now making less return than the market rates, capital is preserved). This is effectively an option on bond prices which has to have some value, which you could add to the total theoretical expected return?

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There are bond managers who actively trade bonds to make gains.. Bonds are not just buy and hold for xx% return in 10 years etc. This is why you can make a loss in a bond fund although it is generally far less likely than a managed share fund.

village idiot said:

I think there was a thread about this but cant find it again so apologies if repeating.

I recently have had cause to have a look at returns for cash deposits and 'fixed interest' securities, both because i am shortly going to need to park a decent chunk of cash somehwere for a while, and also because I am doing a 'foundation of financial planning' module and struggling to get my head round the asset allocation parts of a project, or in particluar struggling to see the point of the 'fixed interest' allocation.

'Australian Fixed interest' appears to include;
govt bonds, returns around 4%
some corporate bonds, only 3 are listed on the ASX website, returns around 8% but never heard of the companies backing them
and 'floating notes' - 20 or so listed by ASX, issued by the big name banks plus AMP , WOW etc
The CBA one has an effective return of 5.55% and the NAB one 7.56%. they go on up from there but only a higher risk

as a comparison there are savings accounts paying up to around 6% floating and around 5.8%fixed interest

queries;

why would an individual ever buy a govt bond which pays 4% v a saving account which pays 6% and is backed by the same govt?

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Short answer is that your savings account gives you no capacity for capital growth. The return you receive is totally created via the interest payment. A bond however has an interest payment (coupon) plus has the capacity to vary it's capital value when interest rates change. A fall in interest rates results in a greater value on the existing bond (the price increases to match the level of return). With a bond it's also possible to use it as a method to capture a high interest rate with the use of bond ladder for a considerable period of time.

Fixed interest is supposed to be slightly higher up the scale of both return and risk. I can see how it might be further up the scale of risk but not sure about the return. If both govt bonds and NAB notes were included, say 50% each , the return would be the average of 4% and 7.5% = 5.75%, which you can get in the bank. The risk side however would now be greater than the default risk of a deposit account with a bank (due to its govt guarantee), and fluctuation of capital risk has now been introduced. So a cash deposit would always dominate 'fixed interest'?

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Only if you consider the additional risk of the note to be not worth the return offerred. Once again many hybrid instruments have a capital aspect to them due to their convertible nature. Investors may wish to take calculated risk for a potentially greater level of return.

An inidividual might gain something by investing only in notes that pay more than 6%, but not in a portfolio that included govt bonds


I am further baffled by; why would an individual ever give his money to an institution which will charge him say 1.5% pa for investing at 4% or 6% return? thanks very much. In the case of a managed fund, in or out of super, a typical 'balanced' portfolio would have 40% in cash and fixed interest asset classes, which might as well be all in cash from what i can see, yet they charge their fees on the whole lot. that means that for 40% of the fund you would be donating 1.5% in fees for the same or less return than you could get in a bank.

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Most financial advisers are salespeople first and advisers second. Welcome to an industry where the majority will sell their soul for a quick buck. I only use my Jedi powers now for good.

An individual who wants 40% defensive assets would surely be better putting his cash in the bank himself at 6%, with no entry or exit fees, and then putting the other 60% in growth funds (if he was unwilling to do direct investments). that way at least he would only be paying 1.5% on 60% of his money. Just saving 1.5% on 40% is a .6% pa improvement in the overall portfolio perforamance.

any comments appreciated thanks

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Fixed interest definately has its place in a well structured investment portfolio. Due to the taxation profile of fixed interest (which has been addressed in the Henry report), it tends to be somewhat of a mugs game. Individuals on higher MTR's tend to have a negative real rate of return except at the high points of the fixed interest cycle, which is a window that lasts ~ six months in an average 8 year cycle. Accordingly it needs to be used sparingly and provide benefits to the individual in terms of flexibility and risk management that outweigh the poor level of performance of the asset class. The exception to this is bonds, which have the ability to be an appreciating asset, and an asset that allows gearing strategies to be employed. Levels of return on own funds using geared bond strategies can be highly lucrative.

This is however outside the reach of most investors although a small investor bond facility was opened by the Reserve Bank which allows a minimum $50,000 investment. Still outside the reach of some but much more achievable than the normal $500,000 wholesale rate.

Cheers

Sir O

thanks Sir O for your reponse.

"has the capacity to vary it's capital value", otherwise known as volatility or risk, which is generally regarded as a negative in investment assessment ie by one common yardstick the higher the return/volatility number the better
However in the case of FI, if structured right the investor has the option to exit pre maturity if the capital value varies (which he would only tend to do if the value had varied in an upwards direction), or hold till maturity an get his capital back.
If so, in this case volatility is actually a benefit, like being long gamma with an option, but this is an option that otherwise pays a positive return with time rather than a negative one?

Is that making any sense?


I have another question but am going to PM you with that

cheers

village idiot said:

thanks Sir O for your reponse.

"has the capacity to vary it's capital value", otherwise known as volatility or risk, which is generally regarded as a negative in investment assessment ie by one common yardstick the higher the return/volatility number the better

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I typed up a response but must have stuffed the quote tags and lost it by clicking away...here it is in brief.

Risk/return profile exist in all asset classes. Is the potential return worth the additional risk?

However in the case of FI, if structured right the investor has the option to exit pre maturity if the capital value varies (which he would only tend to do if the value had varied in an upwards direction), or hold till maturity an get his capital back.
If so, in this case volatility is actually a benefit, like being long gamma with an option, but this is an option that otherwise pays a positive return with time rather than a negative one?

Is that making any sense?

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You're forgetting the coupons that are paid reduce the value (but not the capital value which is independent), as less money will be distributed over the remaining life of the bond. Time/value for bonds has a time decaying profile like an option, but instead of expiring worthless, the bond pays the face value. The volatility in the capital value can of course act for or against the holder. This is why bond trading exists using leveraged instruments, but it's being pulled against by the decreasing number of coupon payments to be made in the remaining life of the bond.

I have another question but am going to PM you with that

cheers

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Hey that's my sign-off!

Cheers

Sir O