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Are your clients in for a shock?

Advisers are being warned to check in with their fixed interest clients before rising interest rates give them a nasty surprise.

Thursday, October 9th 2014, 6:00AM 4 Comments

by Susan Edmunds

David Rey, of Strategi, said rising interest rates were starting to be reflected in lower returns in a number of managed funds and direct bond portfolios.

He said, as rates continued to rise over the next year, that could push some fixed interest investments into capital losses.

Rey said advisers whose clients were highly exposed to New Zealand fixed interest should check their clients’ understanding of their relationship with the adviser business, their clients’ expectations of what the adviser would do to advise them of looming under-performance and how well informed the clients were.

“Did you make low risk investors aware that in a rising interest rate environment, their investment can under-perform the bank and possibly even get a negative return? If you didn’t, then what can you do now to make them better informed?”

Rey said the rising interest rate environment prompted two concerns. “One is that a lot of advisers are using outdated assumptions about what sustainable returns might look like for a balanced portfolio,” he said.

“The other thing is in terms of returns, a lot of retirees are relying on income, we’re in a low yield environment. If advisers are putting large allocations into fixed interest, we have had this situation for a while where you’re running a risk that, looking for yield from fixed interest portfolios, you’re going to find you’re dealing with capital losses when interest rates rise. There are a number of problems there.”

He said it was important that advisers educated clients about the risks of their investments. Some advisers were likely using outdated assumptions and historical returns that would not apply to the future.

“Make sure they understand the returns they received going back 10 or 20 years may not be returns they can look forward to in their retirement years.”
Advisers looking for yield in the stockmarket could find they were overweight in equities, too, Rey said.

“They’re possibly putting clients into a risk profile the client is not really comfortable with. It comes back to the adviser conversation about the level of confidence the client has with various risk factors and what capacity they have to carry the risk factors going forward.”

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Comments from our readers

On 9 October 2014 at 9:51 am Brent Sheather said:
I am not sure whether clients are in for a shock but Mr Rey of Strategi might be shocked to learn that, contrary to the first paragraph, interest rates are falling not rising, especially at the long end of the curve. In the quarter ended September 30 the Government Stock Index returned 1.8% and long dated SOE bonds have returned 10% year to date so the comment that “rising interest rates were starting to be reflected in lower returns in …. bond portfolios” is a little incorrect. Incidentally anecdotal evidence suggests many clients of intermediaries have missed the boat here because so many advisers thought interest rates were going to rise. 10 year US treasuries started the year at 3.0% and they were around 2.34% last night.

On 9 October 2014 at 1:10 pm Graeme Tee said:
Mr Rey should stick to compliance and CPD training, not forecasting interest rates. As usual Mr Rey does not quantify the capital movement on a short term or long term bond of a given movement in interest rates. Instead he just likes to raise the fear factor. A 1% rise in interest rates has a vastly different outcome on a 20 year bond compared to a 5 year bond.

Is this an example of CPD training from Strategi? If so the trainees are the ones in for the shock.
On 9 October 2014 at 10:10 pm Peter43 said:
You may be right Brent, interest rates lower for longer, but I think the article is trying to explain that eventually the tide will turn and clients of some advisers will get a nasty surprise.
On 10 October 2014 at 10:45 am doomben said:
Not quite sure why you think David is incorrect? The advice given seems fairly generic and I don't see any specific dates or returns quoted.

Most govt bonds rates are higher now than their last trough (NZ 10-year bonds bottomed at 3.15% for instance and are about 1% higher now).

It certainly is not implausible to say they could go higher (10-year average is 5.3%).

Reminding advisors about (1) the potential for capital loss on longer term bonds if interest rates rise, (2) to be careful if they have lifted the equity allocation in portfolios due to low interest rates, and (3) to reassess what is a plausible forecast return on balanced portfolios does not sound like bad advice to me.

More like the equivalent of a doctor saying you should quite smoking and get more exercise. Good advice, but unlikely to be followed.

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