Tower investors taught a timely lesson

By MARK FRYER

If they didn't know already, Tower shareholders are now only too aware of the dangers of owning shares. But there's another lesson in Tower's fall: fixed interest investments aren't always the sure thing they seem, either.

While most of the attention has been on the plunging share price, another group of investors have been caught in the fallout from Tower's problems.

They are the 5000 or so people who put $125 million into Tower capital bonds this year. Issued in April, the bonds are a type of fixed-interest investment and attracted investors with the promise of an 8.75 per cent return, paid every three months until October 2007 at least.

In the long run, Tower's problems may not harm those hopes. In the short term, they show that even apparently secure fixed-interest investments are far from risk-free. That's a timely lesson, given the steady stream of similar fixed interest deals offering tempting interest rates.

But first, a recap. At the beginning of this month, fund manager and insurance company Tower announced that its profit for the year to the end of September would, in fact, be a loss, of $30 million to $40 million.

Given that sharemarket analysts had been forecasting a profit of $53 million to $71 million, this was not welcome news and Tower's share price plunged.

The shares were last sighted trading at $1.70, compared with $3.55 before the gloomy outlook was revealed, so a stake in Tower is now worth less than half as much as it was.

At this point, anyone who bought Tower capital bonds might be feeling a little smug. Their investment may not be as exciting as shares, but it is still paying the promised 8.75 per cent. But they haven't escaped entirely.

Like Tower's shares, the company's capital bonds are bought and sold on the sharemarket, albeit in much smaller numbers. Many other fixed interest investments trade in the same way, including Government stock, corporate bonds and capital notes.

One thing that makes those traded investments different from, say, bank term deposits, is what happens if you want to get your money out.

Rather than going back to the issuer and receiving a set amount, you sell on the market and get whatever other investors are willing to pay.

In Tower's case, just before the shock announcement its bonds were trading for more than their face value. Investors with $5000 worth could have sold their bonds and got back slightly more than their investment, as well as keeping the two interest payments Tower has already made.

But as soon as the bad news was out, the bonds' value plunged. As of yesterday, an investor selling $5000 worth would have received around $4600. That's a far cry from the savaging Tower's shares have suffered, but it's still unwelcome news for anyone who assumed they were putting their money into a "safe" investment.

The fall in the bonds' value reflects the fact that Tower is now regarded as financially weaker than it was before the profit warning. Would-be investors have less faith in its ability to keep making the interest payments, and are therefore prepared to offer less for the bonds.

None of which may worry investors who plan to hold their bonds for the long term. All that matters is that they go on receiving the promised payments.

And, given the relatively small numbers of bonds that change hands - about $900,000 worth in the fortnight since Tower delivered the bad news - it seems that most investors fall into that category.

But there is a lesson here: before buying any tradeable fixed-interest investment, be sure you're in for the long haul. Or, if there's a chance that you may have to get out early, be aware that you could lose money (you could make money, too, but that's probably not why most people buy into fixed interest investments).

Even long-term investors haven't escaped scot-free. For them, the obvious danger is that Tower may not be able to keep up the interest payments. How high is that danger? Short answer: higher than it was.

Wellington company Grosvenor Financial Services Group, which offers free ratings of many fixed interest investments on its website (www.bondwatch.co.nz), initially gave Tower's bonds a "G5" rating, on a scale from G1 for the most secure investments to G8 for the riskiest.

Grosvenor says a G5 rating means an issuer has an adequate ability to meet its current obligations, but the longer-term picture is less certain.

That rating is under review, says David Beattie, Grosvenor's chief investment officer, and is likely to drop at least one notch on Grosvenor's scale. It could fall further, depending largely on the situation at Tower's Australian financial planning business, Bridges, which Tower has not yet revealed.

Beattie says investors in things such as capital notes often don't appreciate the dangers. One is the fact that issuers who don't make the promised interest payments aren't technically in default, leaving investors without recourse. The other major risk is that such investments are in perpetuity. "There's not a magical date in the future when the company's just going to give them [investors] a cheque."

As always in the investment business, there's another way of looking at this, if you're feeling brave.

As of yesterday, you could earn a return of about 11 per cent by buying Tower's bonds. That comes from a combination of the 8.75 per cent interest payments, plus the capital gain you can get by buying the bonds for less than their face value.

If that appeals, feel free. But remember there's a reason for that 11 per cent. And the reason is risk.

* To contact personal finance editor Mark Fryer write to: Weekend Herald, PO Box 32, Auckland. Email: mark_fryer@nzherald.co.nz. Ph: (09) 373-6400 ext 8833. Fax: (09) 373-6423.