Pitfall for financial fashion followers

By MARK FRYER

Even the supposedly sober investment business is susceptible to the whims of fashion.

Right now, fixed-interest investments are all the rage. Hardly a week goes by without some company announcing an issue of capital notes, subordinated bonds or some other variation on the theme.

With the puny returns now available on bank term deposits, it's not surprising that investors have poured their money into such offers.

One of the latest fixed-interest deals is from WestpacTrust, which is offering "retail bonds" paying 5.5 per cent a year for the next three years, for anyone with at least $10,000 to invest.



The interest rate isn't spectacular, about 0.6 per cent higher than WestpacTrust offers on term deposits of a similar duration, but the bank's strong credit rating means they're much more secure than many recent fixed-interest issues.

But there is a catch, not just with WestpacTrust's bonds, but with all such investments.

That catch means anyone who assumes these are much the same as a term deposit could be in for a nasty surprise.

The catch? If you want to get out of such an investment before the maturity date, you could suffer a loss that could eat up much of the interest you've earned.

WestpacTrust's advertisements acknowledge that danger, warning that "Retail Bonds sold before their maturity date may yield a capital gain or loss".

What may come as a surprise to novice investors is how big that gain or loss can be.

If you want to get out of an investment like this early, you do so by selling the bonds to another investor, usually through a stockbroker, investment adviser or some other intermediary.

But the price you get is not guaranteed, and will depend on what happens to interest rates.

If rates rise, a 5.5 per cent return won't look as attractive as it once did. The only way you will be able to sell your bonds is by accepting less than they cost.

But if rates fall, your bonds will sell for more than they cost, rewarding you with a capital gain.

It doesn't take much of a change in interest rates to have a big effect.

For example, if you decide to sell your bonds after one year, and interest rates have risen by 1 per cent, $10,000 of WestpacTrust bonds will be worth only $9830 or so.

That $170 loss will put a big dent in the $550 in interest you will have received over the year.

If rates rise 2 per cent, your $10,000 in bonds will be worth only $9650 or so.

A fall in rates will have the opposite effect; your bonds will now be worth more than their face value.

In the real world things won't be quite so tidy, since there will be some expense involved in selling your bonds.

None of which matters if you are absolutely sure you will hold the bonds for the full three years.

If you do, you are guaranteed to receive $550 a year for every $10,000 invested, and your money back at the end.

The only danger then is the unlikely prospect that WestpacTrust could get into financial difficulty and be unable to meet its obligations.

But anyone who isn't so certain might want to think twice before buying any fixed-interest investments which can be traded in this way.

They may be flexible, but that flexibility comes at a cost, and the final return may be anything but fixed.