Bonds lose edge

Investors have flocked to bond issues, such as those offered by Manukau City Council. Photo / Peter Meecham

They were the post-financial crisis investment darlings. Now, interest rates little better than bank-term deposits have taken the shine off bonds, leaving retirees and ageing baby boomers wondering where next to put their hard-earned cash.

"I really haven't bought any bonds [for clients] since about April because they just didn't look that attractive," Spicers financial adviser Jeff Matthews said.

In May 2008, he put together a bond portfolio for one client with an average interest rate of 8.9 per cent. Today "you wouldn't be getting within cooee" of that, he said.

Bonds are effectively IOUs issued by governments, local authorities and companies as a means of raising funds. They promise to pay you a certain interest rate for the use of your money over a certain period of time.

As an investment vehicle they provide a regular income stream, are less risky than shares and act as "shock absorbers" in a balanced portfolio, Matthews says.

After the finance company collapses and the wider global financial crisis, nervous investors flocked to bonds in droves.

A bond issue by Fonterra last year had intended to raise $300 million. It was 267 per cent oversubscribed and ended up boosting the dairy giant's coffers by $800 million.

Bonds remain popular. An issue by Manukau City Council this week aimed initially to raise $250 million but the council ended up extending the offer by $100 million.

But unlike the issues of 18 months ago, when rates of about 8 per cent were common, the seven-year Manukau bonds minimum coupon, or interest, rate was 6.45 per cent.

That is slightly better than the Auckland City Council issue of five-year bonds earlier this year, with a coupon rate of 6.28 per cent.

However, banks are offering similar rates on term deposits. BNZ this week had a five-year term deposit rate of 6.5 per cent on $10,000.

The ongoing popularity of bonds is why issuers don't have to offer such attractive terms, says Deborah Carlyon of financial advisory firm Stuart and Carlyon.

"Companies that want to raise money are getting away with paying very low interest rates."

And she advises against sitting tight and waiting for rates to improve because short-term bank deposits pay little.

"People were saying that earlier in the year and missed out, and interest rates have gone lower.

"The longer you wait for them to go up the less you're earning in the meantime." Spread your bond maturities, she says. When the shorter-term ones mature, you can hopefully reinvest the funds at longer-term rates.

Graeme Beckett, head of fixed interest at First NZ Capital, says the simple laws of demand and supply will not necessarily force rates up again. New Zealand organisations of appropriate standing can currently borrow at cheap rates from the United States, so they may not need to turn to the local market.