What is fixed interest? 

Fixed interest investments (also known as bonds) are loans made to governments or companies. When you invest in them, you’re essentially lending money in return for fixed rate interest payments, as well realising the potential for changes in value of the bond itself.

Unlike cash or term deposits, the value of fixed interest securities can go up or down depending on interest rate movements. This is important to note, because while they’re considered defensive investments, and typically offer more stability than shares, they are not completely risk-free. All investments carry a level of risk, and with fixed interest there’s the risk that returns may be lower over time and not keep up with inflation. 

What drives the value of a fixed interest security?

Although the word ‘fixed’ is in the name of the security, the value of the asset is not fixed and can fluctuate over time. The only element that is fixed is the regular interest payment the investor receives as the bond holder, which is typically a fixed amount.   

The main drivers of bond values include the change in market interest rates, as well as the expected change to interest rates. This means that bond prices can shift in anticipation of a rate change, before it even happens. For example, if people think rates will rise soon, bond prices may start to fall ahead of time. 

A bond’s price always moves in the opposite direction to interest rates. This means a higher interest rate usually drives a fall in bond prices or negative returns.  

Low-interest rate environment

• When current market interest rates fall, older bonds become more valuable because they offer higher fixed interest payments than newly issued bonds. 
• These older bonds can be sold at a premium in the secondary market, meaning above their face value. This is because investors are willing to pay more for the higher income stream. 

Rising interest rate environment

• When interest rates rise, older bonds become less attractive because their fixed interest payments are lower than those of newly issued bonds.
• As a result, they may trade at a discount (below face value), leading to potential capital losses if sold before maturity. 
• If the decline in price outweighs the interest income, the bond’s total return can be negative. 

Investors in fixed interest may not even realise that negative returns are a possible outcome.  

What does a negative return scenario look like in practice?

Why investors invest in fixed interest

Unlike cash, fixed interest returns fluctuate over time and can produce both positive and negative returns. However, there are important benefits to investing in fixed interest securities. The two main points are: 

• Over long periods of time, returns in fixed interest tend to be slightly higher than investing in cash and this acts as a reward for holding an asset that moves up and down over time. This can be important in preserving the real (after inflation) value of your savings.  
• In a diversified portfolio, fixed interest investments can play an important diversifying role. The fluctuation in fixed interest returns often moves differently to fluctuations of other classes in diversified portfolios. While not always the case, fixed interest can provide positive returns when share markets go down, and that’s why they’re an important building block of diversified portfolios, including for many of our portfolios at CareSuper. 

How does CareSuper invest in fixed income?