Fixed interest FAQs
As at August 2017, our Fixed Interest option currently comprises 35% cash and 65% fixed interest securities, with most of the fixed interest securities invested in Government bonds.
For clarity, a ‘bond’ and a ‘fixed interest security’ is the same thing and the terms are used interchangeably across the financial services industry.
Returns from bonds are generated from two key components:
- The interest received, and
- The capital movement (or price change) of the bond.
The interest rate is set when the bond is issued and it is a fixed rate. This is where the term ‘fixed interest’ is derived.
Importantly, it is the value of the regular interest payments that is ‘fixed’ and not the market value of the security as a whole. For example, a $100 investment in a bond with a 3% interest rate would pay $3 dollars in interest per year. If the price of the bond does not change, the return on the investment in the bond would be 3% per year.
Yes. Many of our members are aware that the value of shares and other assets can go up and down in the short term, but may not realise that this can also occur with bonds (usually to a lesser extent than shares).
Some of the main factors that affect bond prices include changes in prevailing/market interest rates and interest rate expectations. A bond’s price always moves in the opposite direction to interest rates, so a higher interest rate (or yield) usually causes a fall in bond prices. Generally, bonds do not deliver negative returns very frequently, so many investors are not aware that this is possible.
The key to understanding this critical feature of the bond market is to recognise that a bond’s price reflects the value of the income that it provides through its regular interest payments. When prevailing interest rates fall — notably rates on Government bonds — older bonds of all types become more valuable because they were sold in a higher interest rate environment and are therefore paying a higher regular interest payment than a bond issued today.
Investors holding older bonds can charge a ‘premium’ to sell them in the open market. On the other hand, if interest rates rise, older bonds may become less valuable because their interest payments are relatively low compared to bonds issued today. This means that the older bonds are therefore likely to trade at a discount, leading to lower returns. When the decrease in price (capital value) is greater than the interest payment, the bond’s total return is negative.
In the example of the $100 investment in a 3% bond in the previous question, if interest rates were to rise sufficiently that the capital value of the bond fell to $96, then even with the $3 interest payment, the return on the bond is still a loss of $1 for the year.
Negative returns are not necessarily caused by defaults or the failure of debtors to make repayments.
The value of fixed interest securities has been rising for many years. Since the Global Financial Crisis in 2008, global interest rates have been falling. This has had a positive effect on the price of CareSuper’s existing bond holdings. As a result, our fixed interest investments have had strong positive returns for an extended period. The return of our super Fixed Interest option over 10 years was 6.03% per annum to 30 June 2017 (and 6.94% for the CareSuper Pension Fixed Interest option over the same period).
However, more recently there has been a sustained increase in global interest rates, as reflected by the yield on the 10 year US Government Bond which has risen from 1.47% as at 30 June 2016 to 2.30% as at 30 June 2017. Over the same period the 10 year Australian Government Bond Yield has risen from 1.98% to 2.60%.
This has resulted in the Fixed Interest option returning a modest annual return of 1.77% for super members over the 2016/17 financial year (2.23% for CareSuper’s Pension Fixed Interest option). However, this compares very favourably to the common benchmarks for Fixed Interest investments, with the Bloomberg AusBond Composite Bond Index 0+ Years return of 0.25% and the Barclays Capital Global Aggregate Index (hedged to Australian Dollars) return of 0.47% over the same period.
We encourage members to:
- Familiarise themselves with the option’s risk level, return objective, investment timeframe and likelihood of a negative return as described here.
- Remember that even though the fixed interest asset class can provide more predictable investment returns and be less volatile than shares (and other growth assets), this option may still deliver low or negative returns over certain periods.
- Remember that investing in the Fixed Interest option investment option is quite different to putting money into a term deposit or in a bank deposit, as the market value of fixed interest fluctuates, while the interest payments remain fixed.
- Get in contact with a financial planner* to make sure the investment options you’ve chosen are in line with your risk profile. Through CareSuper, a financial planner* can help you determine your risk profile by asking you a few simple questions. This is a benefit of membership, so you don’t need to pay anything extra for this information.
*Financial advice is offered through CareSuper’s relationship with Industry Fund Services Limited (IFS), and is provided by an authorisation under the Australian financial services licence of IFS, ABN 54 007 016 195, AFSL 232514.