What are Fixed Interest investments?

In simple terms, the Fixed Interest option invests in loans that are made to governments and large companies. These loans are typically for a fixed period of time and pay an interest rate that is set at a fixed level. 

Where do the returns come from?

The return on Fixed Interest investments comes from two main sources.

1. The interest payments received. For example, if a $100 loan is made at an interest rate of 2% per annum, then the return will be $2 every year.
2. The price change at which the loans can be bought or sold on global markets. These market value prices tend to fluctuate depending on the general market outlook as well as the specifics of each investment.

What causes the value of the investments to fluctuate?

There are two key factors that cause market values of Fixed Interest investments to fluctuate:

1. Investors’ sentiment, and particularly sentiment about the ability of the borrower to repay the loan. For example, if a company is experiencing financial difficulty, we would expect the value of its outstanding loans to fall, reflecting the greater risk that investors may not receive all of their interest payments and/or the risk that the loan may not be repaid in full or on time. 
2. The general level of interest rates in the economy. As interest rates fall, the market value of fixed interest investments goes up, and as interest rates rise, their market value goes down. This sounds a little counter-intuitive. But think of it this way: Let’s assume that interest rates are 2% and I invest $100 in a loan that will pay me $2 every year for the next 5 years. If interest rates suddenly drop to 1%, then because my loan still pays me $2 every year, it will become more valuable than the $100 I paid for it because investors now need to invest more than $100 to generate $2 worth of income every year. On the other hand if interest rates suddenly increase to 3%, then my loan will be worth less - because no investor would be prepared to pay $100 for an investment that only generates $2 of income every year.

How risky are Fixed Interest Investments?

In general, Fixed Interest investments are less risky than shares. This is because they generally provide stable interest payments and are often backed by governments and large corporations. Also, companies need to pay interest payments before they can make dividend payments to their shareholders. So Fixed Interest often performs relatively well when share market performance is poor.

As a result of this lower risk, Fixed Interest investments usually have lower expected long term returns than shares. 

But Fixed Interest investments are not risk free. They can deliver negative returns if the underlying borrower gets into financial difficulty or if market interest rates rise. So, the Fixed Interest option doesn’t always deliver positive returns which makes it riskier than investments like cash. 

What does the TelstraSuper Fixed Interest option invest in?

The TelstraSuper Fixed Interest option invests in thousands of different fixed interest investments. We invest in a mixture of short-term and longer-term loans to different governments across the world, as well as many different companies. We also invest in derivative securities, which change in value based on the performance of underlying securities. This diversified approach aims to reduce risk while seeking to outperform the CPI.

What is the estimated outlook for Fixed Interest?

For several years now, interest rates have generally been falling.  In fact, interest rates are now at record lows in most countries.  These falling interest rates have boosted the performance of Fixed Interest investments, for the reasons described above.  So, the last few years have seen unusually strong returns form this asset class.

However, these lower interest rates also mean that future returns from Fixed Interest securities may be lower than the recent past, because the annual interest payments will be lower.  Furthermore, if interest rates begin to rise in the future, this will likely cause the value of Fixed Interest investments to fall and could result in disappointing returns from this asset class.  It is important to keep this possibility in mind when considering this investment option.

Is the Fixed Interest option right for me?

We recommend that you seek advice from a professional financial planner before making investment decisions. To make a booking with an Adviser from TelstraSuper Financial Planning simply call 1300 033 166 or alternatively, request a call back. Although we aren’t seeing people face to face at the moment we are available for appointments via phone and Skype.

 

Any general advice in this article has been prepared without taking into account your objectives, financial situation or needs. Before you act on any general advice in this article, you should consider whether it is appropriate to your individual circumstances. Before making any investment decision, you should obtain and read the relevant product disclosure statement which is available on the Website or by calling 1300 033 166 between 8.30 am and 5.30 pm (AEST) Monday to Friday. You may wish to consult an adviser before you make any decisions relating to your financial affairs. To speak with an Adviser from TelstraSuper Financial Planning call 1300 033 166.