by Rob Hosking
Whether the government intended this or otherwise, the changes mean "it is difficult to justify a benchmark allocation to domestic bonds without imposing a minimum allocation," says Arcus chief investment officer, Peter Verhaart.In theory, a fully hedged global bond portfolio should deliver the same return as a domestic bond portfolio, he says, but this does not happen in practice - and the main reason is New Zealand's persistent comparatively high interest rates.
Those rates mean currency hedging is not a zero sum game - there is a persistent gain to be made.
The change in tax rules, with a capped 5% fair dividend rate for offshore investments, means fixed interest investments which can be caught within that will have a tax advantage, he says.
"Whether or not this was an intended or unintended outcome of the changes to the investment tax regime is unclear."
There will not be any dramatic change, but rather a gradual shift, he says – but the change will not be small. "I'm talking allocations of 20% going to 5% or less." The long-term implication of this for the market is that, if the local bond market is not able to grow and develop, that will only exacerbate the lack of depth and breadth in local fixed interest markets.
That lack "is a key reason why fixed mortgage rates beyond five years are not readily available in New Zealand." The change will happen gradually because most New Zealand fixed interest - about 70% of government bonds – are owned offshore.
"Tactical allocations will also act as a headwind – local managers tend to be underweight in this sector." Overall, Arcus is downbeat about the short-term outlook for the New Zealand economy.
Chief economist, Rozanna Wozniak, says there is a strong likelihood of a "hard landing" next year.
Australian equities are, unlike their local equivalent, expected to be a good buy, she says.
Compared to New Zealand equities, Australia has been undervalued over recent years. Although there is a growing body of opinion that Australia is less favourable compared to other international stocks, the ability of Australian firms to take advantage of the boom in China and India, especially through resource stocks, is still seen as a plus. "At this stage we are comfortable being underweight in the local market in favour of Australia.
Rob Hosking is a Wellington-based freelance writer specialising in political, economic and IT related issues.
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