Last Wednesday the Sydney Morning Herald published an article looking at fixed interest investments - To have or to hold

Fixed interest investments are rarely high on the agenda of the media or backyard BBQ discussions but it is times like now that highlight the need for more focus on fixed interest investments.  For us, fixed interest investments are about reducing the volatility in portfolios and smoothing out returns in portfolios.  They are mostly boring, consistent performing investments but in times like these the value of fixed interest investments can not be overstated.  The average monthly investment returns from the main indices since the beginning of 2008 to the end of August are outlined below:

Annual returns to the end of August were:

On both time periods we can see that cash and fixed interest have well and truly out performed the growth asset classes.  But not all fixed interest offerings are the same.

Unfortunately some investors don't just use cash and fixed interest securities to reduce portfolio volatility, they use these investments to chase returns.  The Sydney Morning Herald article highlighted some distressing returns with the article suggesting fixed-interest funds have lost about 8%.  These styles of funds are not the boring but safe fixed-interest investments most peoples associate with.  They are aggressive funds that use names such as "high-yield", "diversified credit" and "multi-strategy income" and invest in such things as collateralised debt obligations, asset-backed securities and mortgage-backed securities, as well as emerging market debt and non-investment grade corporate debt.

It is now well publicised that these investments have been at the centre of the crisis on financial markets.  Some well know funds which have come unstuck include Absolute Capital, Basis Capital and City Pacific.  Investors were encouraged to invest because these funds promised share-like returns with supposedly less risk.

Our approach to fixed interest is worlds apart from this aggressive approach.  We focus on high quality securities that produce reliable consistent returns over time.  Our preferred investment in the fixed interest area of portfolios is the Dimensional 5 Year Diversified Fixed Interest Trust.  The Trust uses a variable maturity approach which involves no interest rate forecasting.  This approach seeks to identify the countries and maturity ranges with the highest expected returns and generally increases country allocation or extends maturities when the expected returns are significantly higher for a country or for longer term securities. It invests in A1+ short term securities and AA or higher rated long term securities.  Take a look at Dimensional's quarterly update for more information.  The one year return after fees has been 7.46% to the end of August (0.35% above the relevant index.)

Another fund that we do not currently use but worth a look is the Vanguard International Credit Securities Fund (Hedged) mentioned in the Sydney Morning Herald article.  It is invested in over 8,500 securities issued by government owned entities, government guaranteed entities and investment grade corporations.  The one year return has been 6.99% after fees for the wholesale version.

To summarise, fixed interest securities are about smoothing out returns in portfolios, especially crucial in times like now.  It is important to have a well diversified exposure in high quality offerings.  Take a look at our Building Portfolios page for more details about how we incorporate fixed interest securities into our recommended portfolios.

Regards,

Scott Keefer