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FundSource Expresses Caution on Debt Investment

FundSource Expresses Caution on Debt Investment


FundSource Expresses Caution on Debt Investment “Illusion of Safety”

FundSource would like to express extreme caution for the many investors allocating a significant proportion of their savings into income investments such as corporate bonds, finance companies and structured debt securities. The advertising of fixed income returns belies the risks inherent in these structures. Herein the ‘illusion of safety’.

New Zealand is forecast in the near future to face deterioration in it’s business cycle and credit conditions. A weakening in business conditions inevitably leads to increasing credit default rates creating an increased risk that borrowing companies are unable to fulfil their promises to investors. In this circumstance, companies of weaker financial strength may be unable to accommodate the related increased financial stresses. The risks are rising that investors will receive returns below forecast and in some circumstances may experience capital losses.

Risks associated with income investing tend to be episodic – they are benign for much of the business cycle but become severe for short periods. Compounding FundSource’s concern are three factors:

1. Following a benign period for credit risk but in contrast an aversion to the return volatility associated with equity investing, New Zealanders have invested heavily in income assets, potentially creating an over-concentration of investment money in this area;

2. This investment activity has, in Fundsource’s opinion, been underpinned by a general lack of understanding about the varying risks that accompany enhanced yield income investments. This concern is mirrored by a recent Securities Commission discussion paper highlighting a lack of disclosure and understanding of non-bank finance company investments;

3. Some of the income investments being made by New Zealanders are into companies with short operational histories which in turn are investing into business sectors which are highly vulnerable to the a deterioration in the business cycle.

Many New Zealanders have assumed that by placing their money into an asset that promises to pay their principal back at maturity, with regular payments along the way, they are investing into a less ‘risky’ investment.

The illusion of safety. Unfortunately for some investments, this may not prove to be the case. FundSource recommends investors exercise prudence in selecting enhanced yield income securities, which have been found to vary in quality a great deal, and develop a diversified approach to income investing.


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