Quality not quantity

The big trends in the cash and fixed interest markets have been the abundance of capital note issues, the plethora of finance company offerings, and more latterly the arrival of collateralised debt obligation (CDO) backed, high yielding fixed interest offers.

These trends would suggest that so-called “new” product is replacing the more traditional fixed interest offerings from larger players.

That may not be the case. Rather it maybe that investors and advisers have to spend much more time selecting the appropriate cash and fixed interest offerings for their needs.

The criticism of capital notes has been strong from many quarters, principally arguing that most of these offers aren’t rated (when many of them could be), and although investors have been offered returns of close to 10%, they aren’t adequately been rewarded for the risks being taken on. A standard argument is that in the United States investors would be getting much higher interest rates for the same level of risk.

The same argument has also been tendered for the CDO-backed offer-ings. While there is clearly a place for these types of investment, there is a view that the risks have not been well ex-plained to investors, and that like capital notes, the rewards aren’t commensurate with the risks being taken on.

Guardian Trust Funds Management fixed interest manager Fergus McDonald is one who takes this line. CDO-backed investments “serve quite a good purpose,” he says. “But they are not adequately explained.”

On the finance company and capital note side of things there has been plenty said and written about the risk reward equation, but another key issue that investors need to think about is the security behind the various offers put forward.

A look through Good Returns’ deposit rates page (www.depositrates.co.nz) shows that very few of the lending organisations have investment grade ratings from the likes Standard and Poor’s and Moodys. Many of the offers are graded by Grosvenor, but again a large proportion of them rate lower than G6, which is the equivalent of investment grade.

One story that is often circulated is that many of the organisations, including finance companies and capital note issuers, don’t seek ratings for their products as they know that the outcome won’t be particularly high, and a poor rating is likely to do more damage than good.

Another recent development is comments by a number of organisations concerned about the actual risks in the lending market at the moment.

One of the starker comments was made at Dorchester Pacific’s recent annual meeting in Auckland.

Managing director Brent King said that the company had been looking at expanding into the retail lending market but has now decided not to.

“We raised last year that we may seek to interact with some retailers to see if we could obtain some retail lending,” he says. “We have made the decision not to do so as the market appears to be over supplied plus we have concerns about the credit risks that are emerging in this area.”

He also commented there are some “are some real risks within the New Zealand market, particularly in regards to property development and the high level of personal debt.”

The issue for investors and advisers is that they need to consider a myriad of issues when they look at fixed interest offerings and it is vitally important that they understand the security behind an offer, where the money is being lent and the risks associated, before making any decisions.

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