A new option for fixed interest
One thing you can safely say about the fixed interest sector is that there is no shortage of investment choices.
Tuesday, February 20th 2007, 2:20PM
Beside the traditional fixed interest managed funds and direct holdings of fixed interest securities there are capital notes, finance company debentures, bank deposits and hybrid investments such as Liontamer’s Money Fund.Fidelity Life’s Options Portfolio, launched in August 2004, has been an interesting addition to the sector. The portfolio invests in short-term cash deposits and uses these as a security for options contracts that enhance returns.
The fund is a Fidelity Life product, but it is actually managed and run by Tyndall Funds Management. Tyndall’s fixed interest boss Fergus MacDonald says he dreamt up this idea about eight years ago but it only came to fruition with Fidelity in 2004.
While it is a fixed interest type investment, it can be classed as an alternative investment or a hedge fund, he says with some caution about the latter term. “Hedge funds have this connotation of being quite risky.” However MacDonald is quick to point out although the fund uses options and leverage (an effective rate of about five times),it isn’t highly risky.
One of the pluses of the fund is that because it is mainly invested in sovereign debt there isn’t the credit risk that is associated with things such as finance company debentures. MacDonald says investors using the fund are not exposed to equities, property or commodities; rather they are exposed to interest rates.
With the options the fund is in the money unless interest rates move more than 25 basis points in a day. Historically that doesn’t happen very often, however MacDonald expects to exercise options two or three times a year.
He says the Options Portfolio has some characteristics of a hedge fund, such as its investment focus is on absolute or total returns as opposed to being against a benchmark. Also it uses leverage as well as put and call options.
A big issue for investors and advisers in a rising interest rate market is that they may at some stage suffer capital losses in their fund. MacDonald says that the probability of this happening is quite small.
“I don’t want to say you can’t have capital losses with the fund, because you can,” he says. The issue he points out is that because the fund uses options its performance isn’t linked to the direction interest rates are moving in. “If interest rates rise it doesn’t necessarily mean that you are going to have losses,” he says. “The returns aren’t dependent on the direction of interest rate movements.”
An added benefit of this fund is that it has some tax efficiencies. MacDonald says the effective tax rate on the fund is about 25% because Fidelity, as a life insurance company, has some tax losses it can use to lower the fund’s tax rate.
The proof of the pudding is in the eating. The Options Portfolio has comfortably exceeded its own target of 10% per annum after tax and fees with an impressive 11.89% per annum after tax since inception.
With a return of 11.89% pa after tax since inception in 2004, Fidelity Life’s Options Portfolio has proved an excellent investment.
Fidelity Life’s Options Portfolio is an alternative
investment that aims to achieve over 10% per
annum after tax and fees by investing in cash
deposits, bills and other short-term financial
instruments, and issuing derivatives.
For the first time in New Zealand, investors can access
an alternative asset class structured around fixed
interest rather than equities. What’s more, it’s available
for both lump-sum and regular contributions.
What sort of performance can be
expected?
It is a high-volatility investment choice that aims to
achieve over 10% per annum after tax and fees. We
expect three months in every twelve to show a negative
return. Launched in August 2004, the Options Portfolio
returned 13.35% after tax and management fees in the
year to 31/12/06, and an impressive 11.89% pa since
inception.
Who manages the Portfolio?
Tyndall Investment Management manages the portfolio
in terms of an agreed mandate. Tyndall is one of the
largest and most experienced fixed interest managers in
New Zealand and has achieved some excellent returns
in the New Zealand fixed interest markets. Fidelity Life
is a Morningstar 4-star manager and is in the top four in
New Zealand.
How does it work?
The Options Portfolio invests in cash deposits, bills and
other short-term financial instruments with a credit rating
a notch or two above the minimum investment grade.
The assets are then used as collateral security for
derivatives, in particular by selling options on long-term
Government stock. Most options are issued for one
month and provide the institutional purchaser with a
payout if interest rates move by more than a prescribed
margin in one particular direction.
The size of a payout depends on the magnitude of interest rate changes. The portfolio earns a premium for selling the options. The option premium is added to the interest on the pool of assets to achieve a superior return. However, if interest rates move beyond the “strike price”, the options will move “into the money” and the loss in value is debited against the Options Portfolio.
In such cases
clients may lose some of the value of their capital.
Options may be issued for 10 times the value of the
underlying assets, with a “strike price” at least 25 basis
points away from the current price.
A stop-loss strategy is in place to restrict the maximum
loss in any one month. In the unlikely event that there
is a discontinuity in markets, it may not be possible to
execute the stop-loss strategy.
Who is it suitable for?
The Options Portfolio is a high-return/high-volatility
investment. While returns should be very favourable
over time, their volatility means that investors should be
investing for the medium to long term – at least three
years.
How can clients invest in the Options
Portfolio?
The Options Portfolio is not a separate product. It is an
additional portfolio in Fidelity Life’s products, including
Power Saver (low-cost regular savings), Power Super
(a registered super scheme) and Life Bonds (lump-sum
investment). Investments are made on the application
form in the Fidelity Life investment statement. The
minimum investment is generally $100 per month or
$2,000 lump sum.
For more information contact your Fidelity Life BDM, or call 0800 88 22 88.
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