While the potential risk of lost opportunity caused by tying up cash in term deposits is by itself a powerful argument for preferring bonds in a fixed interest strategy, there are other persuasive reasons to invest in bonds at the moment, Roger Bridges, head of fixed income at Tyndall AM says.
A study by Tyndall shows that in the last decade bonds have outperformed term deposits, as well as being negatively correlated with equities except for a brief period in 2004-2005.
“Investors seem to misunderstand the relationship between term deposits and equities,” Mr Bridges said.
“A common misconception about term deposits is that they are similar to fixed interest in providing good diversification in a portfolio, vis a vis equities.
“However, term deposits have mostly been positively correlated with equities and even when they were negatively correlated, this tends not to be as strong as for bonds.
“In other words, bonds provide better diversification than term deposits in a portfolio at times of equity market volatility,” he said.
Mr Bridges said that investors with term deposits that are currently reaching maturity will find returns on any new term deposits are much less attractive than they have been in the last five years.
“The question for such investors is how to best position their portfolios in an environment where interest rates are flat, or even, as we are now seeing, falling.
“This reinvestment risk is a key reason why we believe the outlook is now less favourable for term deposits than the past few years have been,” he said.
Mr Bridges said that a key factor in why fixed interest securities should now outperform term deposits is because term deposits don’t “mark to market”.
“That is, they aren’t continually re-priced whereas bonds are,” he said.
“This means that investors in term deposits won’t benefit from the capital appreciation that bond investors gain in markets where fixed income investments are performing strongly.
“Bonds also tend to have higher returns than term deposits, particularly when interest rates are falling,” Mr Bridges said.
Tyndall AM offers Australian and global fixed interest funds and Australian and international equities to retail and institutional investors in Australia. It has over A$22 billion in funds under management (as at 31 December 2011). It is a wholly owned subsidiary of Nikko Asset Management Co., Ltd., the largest regional asset manager headquartered in Asia with approximately A$151 billion in funds under management (as at 31 December 2012).
The contents of this release are general by nature, and should not be construed as investment advice. Individuals should take the advice of a financial planning professional or undertake their own research to allow decisions based on their own needs and circumstances.
For further information please contact:
Roger Bridges – Phone: 02 8072 6350
30 April 2012