Investors urged to be cautious about income investments

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Investors should be extremely cautious about putting a significant proportion of their money into income investments, research house FundSource says.

Monday, October 18th 2004, 6:20AM

In particular it is warning about investments such as corporate bonds, finance companies and structured debt securities.

“New Zealand is forecast in the near future to face deterioration in its business cycle and credit conditions. A weakening in business conditions inevitably leads to increasing credit default rates creating an increased risk that borrowing companies are unable to fulfil their promises to investors,” FundSource general manager Tim Anderson says.

“Companies of weaker financial strength may be unable to accommodate the related increased financial stresses. The risks are rising that investors will receive returns below forecast and in some circumstances may experience capital losses.”

FundSource says many of the risks can be benign for much of the business cycle but when things turn the results can become severe.

Compounding FundSource’s concern are three factors:

1. Following a benign period for credit risk but in contrast an aversion to the return volatility associated with equity investing, New Zealanders have invested heavily in income assets, potentially creating an over-concentration of investment money in this area
2. This investment activity has, in Fundsource’s opinion, been underpinned by a general lack of understanding about the varying risks that accompany enhanced yield income investments. This concern is mirrored by a recent Securities Commission discussion paper highlighting a lack of disclosure and understanding of non-bank finance company investments
3. Some of the income investments being made by New Zealanders are into companies with short operational histories which in turn are investing into business sectors which are highly vulnerable to the a deterioration in the business cycle.

“Many New Zealanders have assumed that by placing their money into an asset that promises to pay their principal back at maturity, with regular payments along the way, they are investing into a less ‘risky’ investment.”

FundSource recommends investors exercise prudence in selecting enhanced yield income securities, which have been found to vary in quality a great deal, and develop a diversified approach to income investing.

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