OPINION: With the Reserve Bank raising the official spot rate to 0.75% and signaling that it is firmly in a cycle of rising interest rates, it looks like that period of record interest rates are now behind us.
Most of the headlines focused on the potential impact on residential property prices given the flow on the effect of rising mortgage rates and other assets such as stocks.
However, the asset class directly affected by fluctuations in market interest rates is that of fixed income assets, such as bonds. Bonds are basically debt, which can be issued by a company or a country, at a fixed or floating rate of interest, for a specified period until the bond matures and the debt is repaid. to the investor.
If market interest rates fall, a bond’s market price rises because its fixed interest rate that was set earlier now looks more attractive. Conversely, if market interest rates rise, the bond’s price will fall because investors will see the interest rate paid on the bond as lower than the new market rate.
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Global interest rates have been trending steadily downward since the 1980s, when some readers may remember mortgage rates of 16%.
As a result, bond investors have enjoyed a big tailwind in terms of yield, with very little movement against them in terms of negative price movements. However, that could change in 2021.
In what could only be described as a truly remarkable month, October 2021 saw New Zealand’s two-year interest rate jump 0.87%. While that might not seem like much, it is actually the biggest month-long move since 1999.
Bond funds have been popular with investors, but rising interest rates during 2021 put enormous pressure on the returns of New Zealand bond managers. Investors often think bonds can’t lose money, but over the past 12 months three of New Zealand’s biggest bond funds have lost between 8.5% and just over 10%.
Bond funds have been viewed as a safe and prudent investment, so many investors in these funds have likely suffered losses that they did not even suspect the possibility of.
But it’s not just investors in New Zealand bond funds that are suffering, investors in conservative KiwiSaver funds have likely noticed that their balances have stagnated or been declining in recent months.
Indeed, most conservative KiwiSaver funds by nature and design have a large allocation to bond markets, especially New Zealand bonds, which suffered losses.
At Pathfinder, we have made an active decision to underinvest in listed bonds. Check out how your KiwiSaver manager has positioned their fixed income allocations, as some managers have certainly done a better job than others in the face of rising interest rates.
In summary, supporting actions from central banks globally and the Reserve Bank here in New Zealand have seen the value of bonds and stocks rise at the same time.
With interest rates finally appearing to rise, this golden loop relationship may no longer hold in the short term and bond investors may experience more difficulty in the short term. The message for investors is to verify that your savings are being invested with the risk of higher interest rates in mind, as investing in long-term bonds is no longer the easy one-way bet it is. has been for so long.
Hamesh Sharma is a portfolio manager at ethical fund manager and KiwiSaver Pathfinder Asset Management Provider, which is part of Alvarium Wealth.