Beside the traditional fixed interest managed funds and direct holdings of fixed interest securities there are capital notes, finance company debentures, bank deposits and hybrid investments such as Liontamer’s Money Fund.
The latest, and highly interesting, offer to hit the market is Fidelity Life’s Options portfolio.
Life Options is an investment that buys Australian and New Zealand government bonds, plus some bank paper, and uses options to enhance the returns.
The fund is a Fidelity Life product, but it is actually managed and run by Tyndall Funds Management.
Tyndall’s fixed interest boss Fergus MacDonald says he dreamt up this idea about eight years ago but it has only come to fruition with Fidelity at the end of last year.
While it is a fixed interest type investment, it can be classed as an alternative investment or a hedge fund, he says with some caution about the latter term.
“Hedge funds have this connotation of being quite risky.” However MacDonald is quick to point out although the fund uses options and leverage (an effective rate of about five times), it isn’t highly risky.
One of the pluses of the fund is that because it is mainly invested in sovereign debt there isn’t the credit risk that is associated with things such as finance company debentures.
MacDonald says investors using the fund are not exposed to equities, property or commodities; rather they are exposed to interest rates. With the options the fund is in the money unless interest rates move more than 25 basis points in a day.
Historically that doesn’t happen very often, however MacDonald expects to exercise options two or three times a year. He says the Options Portfolio has some characteristics of a hedge fund, such as its investment focus is on absolute or total returns as opposed to being against a benchmark. Also it uses leverage as well as put and call options.
A big issue for investors and advisers in a rising interest rate market is that they may at some stage suffer capital losses in their fund. MacDonald says that the probability of this happening is quite small.
“I don’t want say you can’t have capital losses with the fund, because you can,” he says. The issue he points out is that because the fund uses options its performance isn’t linked to the direction interest rates are moving in.
“If interest rates rise it doesn’t necessarily mean that you are going to have losses,” he says.
“The returns aren’t dependent on the direction of interest rate movements.” An added benefit of this fund is that it has some tax efficiencies.
MacDonald says the effective tax rate on the fund is about 25% because Fidelity, as a life insurance company, has some tax losses it can use to lower the fund’s tax rate.
And of course the other point that should make investors and advisers sit up and look at the Options Portfolio is that it expects to generate returns of 10% annually after tax and fees.
NEXT STORY on the Options Portfolio: Adding zing to fixed interest
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