# Cash vs. fixed interest as asset classes



## village idiot (12 March 2012)

I think there was a thread about this but cant find it again so apologies if repeating.

I recently have had cause to have a look at returns for cash deposits and 'fixed interest' securities, both because i am shortly going to need to park a decent chunk of cash somehwere for a while, and also because I am doing a 'foundation of financial planning' module and struggling to get my head round the asset allocation parts of a project, or in particluar struggling to see the point of the 'fixed interest' allocation. 

'Australian Fixed interest' appears to include;
govt bonds,  returns around 4%
some corporate bonds, only 3 are listed on the ASX website, returns around 8% but never heard of the companies backing them
and 'floating notes' - 20 or so listed by ASX, issued by the big name banks plus AMP , WOW etc
The CBA one has an effective return of 5.55% and the NAB one 7.56%. they go on up from there but only a higher risk

as a comparison there are savings accounts paying up to around 6% floating and around 5.8%fixed interest

queries;

why would an individual ever buy a govt bond which pays 4% v a saving account which pays 6% and is backed by the same govt?

Fixed interest is supposed to be slightly higher up the scale of both return and risk. I can see how it might be further up the scale of risk but not sure about the return. If both  govt bonds and NAB notes were included, say 50% each , the return would be the average of 4% and 7.5% = 5.75%, which you can get in the bank.  The risk side however would now be greater than the default risk of a deposit account with a bank (due to its govt guarantee),  and fluctuation of capital risk has now been introduced. So a cash deposit would always dominate 'fixed interest'? 

An inidividual might gain something by investing only  in notes that pay more than 6%, but not in a portfolio that included govt bonds


I am further baffled by; why would an individual ever give his money to an institution which will charge him say 1.5% pa for investing at 4% or 6%  return? thanks very much. In the case of a managed fund, in or out of super, a typical 'balanced' portfolio would have 40% in cash and fixed interest asset classes, which might as well be all in cash from what i can see,  yet they charge their fees on the whole lot. that means that for 40% of the fund you would be donating 1.5% in fees for the same or less return than you could get in a bank. 

An individual who wants 40% defensive assets would surely be better putting his cash in the bank himself at 6%, with no entry or exit fees, and then putting the other 60% in growth funds (if he was unwilling to do  direct investments). that way at least he would only be paying 1.5% on 60% of his money.    Just saving 1.5% on 40% is a .6% pa improvement in the overall portfolio perforamance. 

any comments appreciated thanks


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## Bill M (12 March 2012)

village idiot said:


> queries;
> 
> why would an individual ever buy a govt bond which pays 4% v a saving account which pays 6% and is backed by the same govt?




I have often wondered this myself. I invest in both fixed interest and cash and I only hold government bonds through my industry super fund.



> An inidividual might gain something by investing only  in notes that pay more than 6%, but not in a portfolio that included govt bonds



And that is why I don't invest in Government bonds directly, but I do invest in hybrids and floating rate notes.



> I am further baffled by; why would an individual ever give his money to an institution which will charge him say 1.5% pa for investing at 4% or 6%  return? thanks very much.



I only do it in my industry super funds, why? Because the fees are very very low like .05% nothing like the fees you suggest. On that basis (super fund only) it is not a bad deal for the return. For the first 6 Months of the financial year this year my super fund in cash and fixed interest 50/50 paid me 5% already. To beat that I would have to invest in an UBANK account at 6.01% and then pay tax on top. The super funds return was after tax. Remember 5% for 6 Months means 10% per annum. Ok, lets say I pull an extra 2 or 3 % between now and the end of financial year then I am doing very well..

Apart from that, I invest outside of super. The lowest paying interest income security I have is 6% and that is from a floating rate note that was sold in the 90's. 6% as a minimum is not too bad, most of my interest rate stocks return a lot more, my highest is SVWPA 11% gross, cheers.


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## village idiot (12 March 2012)

> For the first 6 Months of the financial year this year my super fund in cash and fixed interest 50/50 paid me 5% already. To beat that I would have to invest in an UBANK account at 6.01% and then pay tax on top. The super funds return was after tax. Remember 5% for 6 Months means 10% per annum.




thanks for your reply bill. So if the cash and FI were split 50/50, and the cash part made say 3% of 50% =1.5%that means the 50% FI part must have made 3.5%, equiv to an annual rate of 14%. any idea what it was invested in to produce that return?

thanks


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## Bill M (12 March 2012)

village idiot, it is best that I just do a screen shot from their website to show the returns. I had 50% in Australian fixed interest and 50% cash.

And here is what is written on their website regarding the Australian Fixed Interest part.:
---
This option aims to achieve investment returns above inflation over the medium term. The portfolio is designed to hold a diversified range of interest-bearing securities, and its performance is benchmarked against the UBSW Composite Bond Index. Although fixed income securities typically deliver a steady stream of investment returns, over short time periods fixed income portfolios can deliver low or even negative investment returns.
http://www.firststatesuper.com.au/TalkingSuper/InvestmentStrategies/AustralianFixedInterest
---


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## Knobby22 (12 March 2012)

Australian Super now lets you invest directly in the term deposit of your choice.

I think the other industry funds will soon offer it as well.

http://www.australiansuper.com/inve...e/super-investment-choices/member-direct.aspx


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## Bill M (12 March 2012)

Knobby22 said:


> Australian Super now lets you invest directly in the term deposit of your choice.
> 
> I think the other industry funds will soon offer it as well.
> 
> http://www.australiansuper.com/inve...e/super-investment-choices/member-direct.aspx




Yep, looked into that, the best they can do is ME Banks 5.90% and you got to lock it up for 6 Months, not worth it really. Anything under 6% just isn't worth it.

Also hybrids don't make the grade for 'picking your own". They are out of the top 300 stocks.


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## craft (12 March 2012)

village idiot said:


> I recently have had cause to have a look at returns for cash deposits and 'fixed interest' securities, both because i am shortly going to need to park a decent chunk of cash somehwere for a while, and also because I am doing a 'foundation of financial planning' module and struggling to get my head round the asset allocation parts of a project, or in particluar struggling to see the point of the 'fixed interest' allocation.




On the asset allocation front I think this chart has lots of implications.  Arbitrary allocations to either cash or fixed interest make little sense for long time frames.




Interested to know if my thinking equates to what they teach? Probably not.

Cheers


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## Julia (12 March 2012)

village idiot said:


> as a comparison there are savings accounts paying up to around 6% floating and around 5.8%fixed interest
> 
> queries;
> 
> why would an individual ever buy a govt bond which pays 4% v a saving account which pays 6% and is backed by the same govt?



Indeed.  A question to which I've never seen a sound answer.



> An individual who wants 40% defensive assets would surely be better putting his cash in the bank himself at 6%, with no entry or exit fees, and then putting the other 60% in growth funds (if he was unwilling to do  direct investments). that way at least he would only be paying 1.5% on 60% of his money.    Just saving 1.5% on 40% is a .6% pa improvement in the overall portfolio perforamance.



Perhaps in this you need to take into account people who have these various investments in Super, thus only being taxed at 15%.  I don't know whether avoiding the management fees in managed funds would balance out paying tax at the top rate if investing outside of Super.  I'm assuming that when people have investments in Super/managed funds and they elect the cash option, they are still paying the same management fees as a percentage of capital invested?



Knobby22 said:


> Australian Super now lets you invest directly in the term deposit of your choice.



Overall, the online at call accounts at present are better value than term deposits unless you're up for locking the funds away for several years.  Will they offer at call as well?


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## village idiot (12 March 2012)

thanks for that screenshot Bill. It would seem the returns quoted include capital movement as well which could just as easily go the other way. nevertheless, it was a good browse through there



> Perhaps in this you need to take into account people who have these various investments in Super, thus only being taxed at 15%. I don't know whether avoiding the management fees in managed funds would balance out paying tax at the top rate if investing outside of Super. I'm assuming that when people have investments in Super/managed funds and they elect the cash option, they are still paying the same management fees as a percentage of capital invested?




yes, if you have funds in super, other than a SMSF, theres probably not much you can do about it. I suspect they would be paying the same management fees on the cash component, which if it is the case is an utter rort.

for someone in 30% tax bracket they would actually be better off with the cash component of their overall portfolio in the bank outside super with no fees.


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## Knobby22 (12 March 2012)

Julia said:


> Overall, the online at call accounts at present are better value than term deposits unless you're up for locking the funds away for several years.  Will they offer at call as well?




They have only their own paying 4.81%


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## RandR (12 March 2012)

Julia said:


> Indeed.  A question to which I've never seen a sound answer.




Surely it would be an attractive and reasonable proposition to look at bonds for  institutional sized deposits of $$$. Opening a savings account or two is just not an option when they'd be looking at a big chunk of money to whack away somewhere safe.

Or just for the patriotic ?


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## skc (12 March 2012)

village idiot said:


> queries;
> 
> why would an individual ever buy a govt bond which pays 4% v a saving account which pays 6% and is backed by the same govt?




That may be the case now but will not be the case forever. I assume your asset class allocation module is written for all occassions, rather than just the current interest rate environment.

The other thing to note is that the government guarantee is only up to $1m (or is it $250k) so it is no good for persons with substantial assets, let alone a superfund. 

Now, let's say there is no government guarantee on bank deposits, what interest rate margin would you like to earn above the government bonds to justify the additional risk?


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## craft (12 March 2012)

Julia said:


> as a comparison there are savings accounts paying up to around 6% floating and around 5.8%fixed interest
> 
> queries;
> 
> why would an individual ever buy a govt bond which pays 4% v a saving account which pays 6% and is backed by the same govt?




Govt Bonds are long dated and you can buy in/out hence trade rate movements. You can’t do that with bank deposits also with bank deposits being of shorter maturity you have re-investment rate risk. 



> I am further baffled by; why would an individual ever give his money to an institution which will charge him say 1.5% pa for investing at 4% or 6% return? thanks very much.




Management expenses for cash are normally very low, rates for fixed interest are between cash and equities as you are paying for managing changes in yield to maturity. (ie bond trading) and risk assessment around default risk for corporate bonds.

Well thats what I understand - but I aint no expert.


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## village idiot (12 March 2012)

> That may be the case now but will not be the case forever. I assume your asset class allocation module is written for all occassions, rather than just the current interest rate environment.




a fair point indeed, as I am coming to realise. I am pretty sure they want to see the answer for all occasions as well, but now isnt all occasions.  I am sure they want me to put this poor chap in a balanced managed fund with 40% cash+ FI, paying 1.5% fees on the lot, so i guess thats what he's going to have to get.....


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## Julia (12 March 2012)

skc said:


> The other thing to note is that the government guarantee is only up to $1m (or is it $250k) so it is no good for persons with substantial assets, let alone a superfund.



$250K per institution.  So you can split assets up around various institutions.



> Now, let's say there is no government guarantee on bank deposits, what interest rate margin would you like to earn above the government bonds to justify the additional risk?



I guess we'll consider that when it happens.   Even if the government guarantee is eventually completely withdrawn, can you actually see the government allowing e.g. CBA to fail, even if that looked like a possibility which I don't think it does?


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## Bill M (12 March 2012)

village idiot said:


> cash+ FI, paying 1.5% fees on the lot, so i guess thats what he's going to have to get.....




Just a quick question, why do you have to pay 1.5% fees for a cash and fixed interest option? That is way over any benchmark?? My Super fund charges .05%. The poor bloke will be losing out on fees alone.


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## blue0810 (12 March 2012)

I've received   today a email from betashares :

BetaShares ETFs [info@betashares.com.au]  Mon 12/03/2012 

BetaShares has today announced the listing of the 
first high interest cash ETF on the Australian Securities Exchange
,,,,
,,,,
ETF: AAA


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## Bill M (12 March 2012)

blue0810 said:


> I've received   today a email from betashares :
> 
> BetaShares ETFs [info@betashares.com.au]  Mon 12/03/2012
> 
> ...



Not a good investment in my books. No Government guarantee and only paying 5.2% p/a according to the fact sheet. UBANK pay 6.01% and is Government guaranteed.


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## blue0810 (12 March 2012)

Bill M said:


> Not a good investment in my books. No Government guarantee and only paying 5.2% p/a according to the fact sheet. UBANK pay 6.01% and is Government guaranteed.




 I'm agree with you. less than 6.% Nok.
Just waiting for  other ETS provider to release   the new fixed income  ETFs.


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## village idiot (13 March 2012)

> Just a quick question, why do you have to pay 1.5% fees for a cash and fixed interest option? That is way over any benchmark?? My Super fund charges .05%. The poor bloke will be losing out on fees alone




did you say your fund was an industry fund? cant imagine  a retail fund charging only 0.05% of anything. 

EG just looked up colonial first state;
100% cash fund; they charge .97% pa plus contibution fees + transaction costs (whatver they are)
Balanced fund; 1.52% pa.  
there might be cheaper but I think thats about the going rate


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## Bill M (13 March 2012)

village idiot said:


> did you say your fund was an industry fund? cant imagine  a retail fund charging only 0.05% of anything.




Yes it is an industry fund. The thing is that a Super Manager can't really stuff up a cash investment and has it's set of rules for fixed interest (like must follow an index). In this case I refuse to pay anymore in fees to anyone than what I have too. I just checked the website again, I only actually pay .04% management fees plus a $52 per year admin fee. So for say a 100k balance I only pay $92 per year in fees. Evidence and link attached.
---
http://www.firststatesuper.com.au/TalkingSuper/AdditionalFeeExplanation
---


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## KurwaJegoMac (13 March 2012)

village idiot said:


> why would an individual ever buy a govt bond which pays 4% v a saving account which pays 6% and is backed by the same govt?




Generally speaking an individual wouldn't unless they were particularly affluent. Essentially institutions and VHNWI (Very High Net Worth Individuals >$10m) use bonds. The reasons being: 



The Government Guarantee applies to $250k per institution per customer. So if you have say $5m that you want in deposits, you'd need to have that money split across 20 institutions - that's a lot of paperwork and record management. Doable for sure, but what happens if you are a managed fund and have to deposit $10m or $20m? that's 40 or 80 institutions respectively - are there even that many in Australia covered by the scheme? 



The total income a bond generates is fixed over the life of the bond (like a term deposit) therefore you are not subjected to fluctuations in interest rates like at-call deposits are - in addition, bonds are generally struck with long-term maturities so you've effectively 'locked in' your return - something that an at-call deposit can't do. Generally speaking, bonds will have a higher rate of return than term deposits (not always of course). 


Can be an advantage/disadvantage: Bonds have scope for capital appreciation or depreciation. Also, bonds are very liquid.


In the event of some sort of disaster/collapse, bond holders receive their money before shareholders and depositors. Therefore, if I have bonds with 40 institutions i'm relatively assured that i'll get 100% of my capital back in the event of any of those institutions collapsing. Whereas with an at-call deposit or term deposit I must wait for the ATO, bond holders, share holders and other creditors to receive their investments before I have a return of my capital as a depositor. The more institutions I have deposits with, the greater my risk of not getting my capital back (as more institutions = more points of potential failure/collapse) 

Essentially it boils down to just how much money you are intending to place in fixed income and how well protected you want that deposit to be.


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## village idiot (13 March 2012)

bill, those are stonkingly low fees compared to what i've seen, and i see it is in fact open to everyone. Shame they only deal in super and dont offer the same managed funds outside of super

thanks KJM

I am wondering if another benefit of bonds is that after buying a bond ,  if rates fall and bonds rise, you have a profit if you want to take it, if rates rise and bonds fall, you can hold till maturity and get the original amount of capital expected back (although you would be now making less return than the market rates, capital is preserved). This is effectively an option on bond prices which has to have some value, which you could add to the total theoretical expected return?


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## robz7777 (13 March 2012)

village idiot said:


> bill, those are stonkingly low fees compared to what i've seen, and i see it is in fact open to everyone. Shame they only deal in super and dont offer the same managed funds outside of super.




Low fees alone are not necessarily a good thing, the real figure to look at is return net of fees.. If I am getting above market return what does it matter if the fund charges 2% to employ the best people to achieve the best returns?? 

Same can be said for SMSF, people tent to forget about the Accounting and Admin fees and the cost of your own time when looking at returns..



> I am wondering if another benefit of bonds is that after buying a bond ,  if rates fall and bonds rise, you have a profit if you want to take it, if rates rise and bonds fall, you can hold till maturity and get the original amount of capital expected back (although you would be now making less return than the market rates, capital is preserved). This is effectively an option on bond prices which has to have some value, which you could add to the total theoretical expected return?




There are bond managers who actively trade bonds to make gains.. Bonds are not just buy and hold for xx% return in 10 years etc. This is why you can make a loss in a bond fund although it is generally far less likely than a managed share fund.


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## Sir Osisofliver (14 March 2012)

village idiot said:


> I think there was a thread about this but cant find it again so apologies if repeating.
> 
> I recently have had cause to have a look at returns for cash deposits and 'fixed interest' securities, both because i am shortly going to need to park a decent chunk of cash somehwere for a while, and also because I am doing a 'foundation of financial planning' module and struggling to get my head round the asset allocation parts of a project, or in particluar struggling to see the point of the 'fixed interest' allocation.
> 
> ...




Short answer is that your savings account gives you no capacity for capital growth.  The return you receive is totally created via the interest payment.  A bond however has an interest payment (coupon) plus has the capacity to vary it's capital value when interest rates change. A fall in interest rates results in a greater value on the existing bond (the price increases to match the level of return). With a bond it's also possible to use it as a method to capture a high interest rate with the use of bond ladder for a considerable period of time.







> Fixed interest is supposed to be slightly higher up the scale of both return and risk. I can see how it might be further up the scale of risk but not sure about the return. If both  govt bonds and NAB notes were included, say 50% each , the return would be the average of 4% and 7.5% = 5.75%, which you can get in the bank.  The risk side however would now be greater than the default risk of a deposit account with a bank (due to its govt guarantee),  and fluctuation of capital risk has now been introduced. So a cash deposit would always dominate 'fixed interest'?



 Only if you consider the additional risk of the note to be not worth the return offerred. Once again many hybrid instruments have a capital aspect to them due to their convertible nature. Investors may wish to take calculated risk for a potentially greater level of return.







> An inidividual might gain something by investing only  in notes that pay more than 6%, but not in a portfolio that included govt bonds
> 
> 
> I am further baffled by; why would an individual ever give his money to an institution which will charge him say 1.5% pa for investing at 4% or 6%  return? thanks very much. In the case of a managed fund, in or out of super, a typical 'balanced' portfolio would have 40% in cash and fixed interest asset classes, which might as well be all in cash from what i can see,  yet they charge their fees on the whole lot. that means that for 40% of the fund you would be donating 1.5% in fees for the same or less return than you could get in a bank.




Most financial advisers are salespeople first and advisers second. Welcome to an industry where the majority will sell their soul for a quick buck. I only use my Jedi powers now for good.







> An individual who wants 40% defensive assets would surely be better putting his cash in the bank himself at 6%, with no entry or exit fees, and then putting the other 60% in growth funds (if he was unwilling to do  direct investments). that way at least he would only be paying 1.5% on 60% of his money.    Just saving 1.5% on 40% is a .6% pa improvement in the overall portfolio perforamance.
> 
> any comments appreciated thanks




Fixed interest definately has its place in a well structured investment portfolio. Due to the taxation profile of fixed interest (which has been addressed in the Henry report), it tends to be somewhat of a mugs game. Individuals on higher MTR's tend to have a negative real rate of return except at the high points of the fixed interest cycle, which is a window that lasts ~ six months in an average 8 year cycle. Accordingly it needs to be used sparingly and provide benefits to the individual in terms of flexibility and risk management that outweigh the poor level of performance of the asset class.  The exception to this is bonds, which have the ability to be an appreciating asset, and an asset that allows gearing strategies to be employed. Levels of return on own funds using geared bond strategies can be highly lucrative.

This is however outside the reach of most investors although a small investor bond facility was opened by the Reserve Bank which allows a minimum $50,000 investment. Still outside the reach of some but much more achievable than the normal $500,000 wholesale rate.

Cheers

Sir O


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## village idiot (14 March 2012)

thanks Sir O for your reponse.

_"has the capacity to vary it's capital value"_, otherwise known as volatility or risk,  which is generally regarded as a negative in investment assessment ie by one common yardstick the higher the return/volatility number the better
However in the case of FI,  if structured right the investor has the option to exit pre maturity if the capital value varies (which he would only tend to do if the value had varied in an upwards direction), or hold till maturity an get his capital back.
If so, in this case volatility is actually a benefit, like being long gamma with an option, but this is an option that otherwise pays a positive return with time rather than a negative one?

Is that making any sense?


I have another question but am going to PM you with that

cheers


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## Sir Osisofliver (14 March 2012)

village idiot said:


> thanks Sir O for your reponse.
> 
> _"has the capacity to vary it's capital value"_, otherwise known as volatility or risk,  which is generally regarded as a negative in investment assessment ie by one common yardstick the higher the return/volatility number the better




I typed up a response but must have stuffed the quote tags and lost it by clicking away...here it is in brief.

Risk/return profile exist in all asset classes. Is the potential return worth the additional risk? 







> However in the case of FI,  if structured right the investor has the option to exit pre maturity if the capital value varies (which he would only tend to do if the value had varied in an upwards direction), or hold till maturity an get his capital back.
> If so, in this case volatility is actually a benefit, like being long gamma with an option, but this is an option that otherwise pays a positive return with time rather than a negative one?
> 
> Is that making any sense?




You're forgetting the coupons that are paid reduce the value (but not the capital value which is independent), as less money will be distributed over the remaining life of the bond.  Time/value for bonds has a time decaying profile like an option, but instead of expiring worthless, the bond pays the face value. The volatility in the capital value can of course act for or against the holder. This is why bond trading exists using leveraged instruments, but it's being pulled against by the decreasing number of coupon payments to be made in the remaining life of the bond.







> I have another question but am going to PM you with that
> 
> cheers



Hey that's my sign-off! 

Cheers

Sir O


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