Mary Holm: Love the product, should I buy the shares?

OPINION:

Q: I’m a 27-year-old graphic designer working for a charity in Wellington. In addition to 10 per cent KiwiSaver contributions and rainy day savings, I squirrel away $70 for shares every fortnight.

I have taken many of your suggestions in A Richer You into practice, such as hunting out low-fee providers, and investing in index funds. However, one of my favourite brands (Batchwell Kombucha) has recently launched an IPO through snowballeffect.co.nz.

I have never invested in a single company before, only in funds. Is just liking the brand and its product/service a good enough reason to invest in it? In the context of my already diverse portfolio of index funds, surely it isn’t too much of a risk?

I am planning to hold these shares and my current investments until my eventual retirement, i.e. for 40 years or more.

A: Go for it!

Liking a company and its products is not a good reason to invest a big portion of your savings. Even if the company has great prospects, that is probably widely known so its shares will tend to be expensive. A good company is not necessarily a good investment.

And it might not even be a good company. Many a business that sells great stuff has foundered because of poor management.

However, if you put just a small portion of your savings into this company, it wouldn’t matter much even if the shares became worthless. And it seems you would enjoy the investment. You are an impressive saver, and a long-term investor. Well done. Why not get some fun out of it all?

Rising interest rates

Q: I have read that interest rates will rise and therefore I will lose money if my KiwiSaver fund holds some bonds. Should I be worried?

A: Probably not. But it’s good to understand what’s going on.

Many KiwiSaver funds hold bonds. The exceptions are very low-risk defensive funds that hold only cash, and some high-risk aggressive funds that hold only shares, with perhaps some property.

Bonds are in many ways like bank term deposits. The investor lends the bond issuer — usually a company or the government — some money for a period. The investor is paid regular interest (called coupons), and gets their money back when the bond matures. One big difference from term deposits is that you can usually sell a bond part-way through its term. Also, over the term of a bond, its value goes up and down.

What makes the value of bonds fall?

One reason could bethat the issuer defaults — doesn’t pay interest or give you your money back. But this is unlikely to happen to a great extent in KiwiSaver funds.

The more common reason bond values fall, temporarily, is when interest rates rise.

Let’s say you have a $1000 bond that pays 4 per cent interest and matures four years from now. Next year, interest rates rise, and similar new bonds are being issued at 5 per cent. A bond buyer will prefer the 5 per cent one, unless they can buy yours for less than $1000. The market value of your bond has dropped.

However, a year later interest rates fall. A newly issued bond pays only 3 per cent. Your 4 per cent bond looks appealing, and a buyer will pay more than $1000 for it.

Interest rates and bond values move in opposite directions. When interest rates rise, bond values fall, and the reverse.

Note, though, that this is only temporary. At the end — if you haven’t sold in the meantime — you will still get your $1000 back, as long as there is no default.

These days, with interest rates unusually low, many market watchers think they are likely to rise in future, pushing bond values down. However, interest rates might not rise.

Forecasting rates is notoriously hard. They might even fall further.

A small fall in bond values might be offset by interest received on the bonds.

Even if bond fund balances fall, that’s unlikely to continue for long. Market interest rates won’t keep rising relentlessly.

Over the medium to long term, say three years or more, balances in funds that hold lots of bonds nearly always grow, despite shorter-term fluctuations.

If you are planning to spend your KiwiSaver money within the next three years, put it in a defensive fund. Otherwise, sit tight. Even if your balance falls, it will almost certainly come right.

When 'cash' isn't cash

Q: Warning and query. I have money maturing in a few months. It sits in the “cash” fund to where I switched it, thinking it low risk. Turns out the fund includes bonds. Bonds go up and down in value.

I suspect some people think switching their KiwiSaver to “cash” to protect capital near retirement is akin to moving it to a bank deposit. Wrong — it’s false advertising, whose legality is questionable.

Anyone with a fund expiring in the next 12 months might wonder how to best protect their loot, given they can’t withdraw it. Is a “conservative” fund actually safer than “cash” right now?

A: I was surprised to read that your cash fund holds bonds, as opposed to the usual term deposits and similar. So I checked all the defensive KiwiSaver funds with “cash” in their name in the Smart Investor tool on sorted.org.nz.

Most of them hold only cash. But sure enough, the Summer NZ Cash Fund holds 41 per cent bonds, and the Milford KiwiSaver Cash Fund holds 76 per cent. Also, the Nikko NZ Cash Fund holds 10 per cent bonds.

There’s also Kiwi Wealth Cashplus with 33 per cent bonds, and Booster Enhanced Cash with 95 per cent bonds. And among the conservative funds there’s Fisher Funds’ Cash Enhanced fund, with 54 per cent bonds, 23 per cent shares and property, and only 23 per cent cash. But the names of those three imply that they are not purely cash, so we’ll set them aside — and hope that would-be investors look into what they are investing in.

But what’s going on in the Milford, Nikko and Summer cash funds? Here’s what they tell me.

Milford chose to call 76 per cent of the investments in its cash fund “NZ Fixed Interest”. And “since the Sorted fund finder tool labels all fixed interest securities as ‘bonds’ it is appearing as if a large portion of our fund is invested in bonds, when it is not,” says a spokesperson.

On March 31, “The vast majority of the fund’s NZ fixed interest was invested in certificates of deposit (also referred to as commercial paper), which had three months or less to maturity, and the remainder is in short dated term deposits.”

About 24 per cent of the fund was in cash on-call, and just under 3 per cent in a bond that was maturing in less than two months, he says.

“The current weighted average time to maturity for the certificates of deposit and fixed term deposits held in the Cash Fund is roughly one month.”

As noted in the Q&A above, the value of bonds and other fixed interest investments moves back to their principal amount when they mature. So investments that will mature within a few months are scarcely affected by changes in interest rates.

The issue here seems to be one of language. “We classify the certificates of deposit and term deposits as ‘fixed interest’ while other cash funds may be labelling the same securities as ‘cash and cash equivalents’. You can debate which is correct but Milford has chosen the more conservative description of fixed interest,” says the spokesperson.

He adds that all the investments in Milford’s cash fund are investment grade, which means they are rated “BBB” or higher by Standard and Poor’s or Moody’s. Their issuers are pretty unlikely to default.

Nikko’s cash fund “is a high credit quality portfolio invested across a variety of issuers,” says a spokesperson. “The average maturity date of the fund’s investments is 97 days (as at 31 May 2021).” The fund “only invests in short-term interest-bearing securities, and any bond is required to be within 12 months of maturity.

“In addition, the fund is authorised to hold floating rate notes (FRNs). FRNs are reset each 90 days at an interest rate margin over the 90-day bank bill rate, and therefore have limited exposure to rising interest rates.”

All the bonds in Nikko’s cash fund are “high investment grade, with a minimum credit rating of A long term and A1 short term and no BBBs,” he says.

Summer’s cash fund can hold up to 50 per cent in bonds, says a spokesperson. “At 24 June, our cash fund held 39 per cent in short-term NZ fixed interest. We expect these bonds to give us better returns than money that is on-call or on short-term deposits at a bank.

“All our bonds are investment grade and are publicly listed so could usually be sold on the market if necessary. Most of the bonds mature or are expected to mature this year (one is an ASB note which is likely to be repaid in December 2021). The longest maturity bond matures in April next year.

“We would be remiss if we held all of our cash assets as bank deposits. Banks are not risk-free, and diversification to broaden the portfolio into other short-term securities is prudent for any fund manager,” he says.

Across all three funds, the main point is that their investments are short-term. So rising interest rates are not a concern. An investment in one of these funds seems very unlikely to lose value to any extent.

But if you’re still worried, you can always switch to a cash fund that holds cash only and accept what will probably be a slightly lower average return.

To do this, use Smart Investor to check the different cash funds’ holdings. First, click on “Compare” on the home page and, in the KiwiSaver section, click on “Defensive”. Look at “Details” at the bottom of the “Mix” box for each fund. I suggest you sort by “Fees (lowest first)”, as low-fee funds are just as likely to perform well.

On your question about conservative funds, they are the next risk level up from defensive funds. They typically hold quite a few bonds, including longer-term ones, and 10 to 35 per cent growth assets, which are shares and sometimes property. Conservative funds are not suitable for short-term money, unless you’re willing to risk some ups and downs.

P.S. To avoid confusion, maybe the Smart Investor tool should classify short-term bonds as cash.

More on bonds next week.

Real estate fees

Q: You said last week that you would be interested to hear about any real estate agency that has reduced its commission percentage to take into account the soaring house prices.

Just to let you know that we have. Our commission rate has nearly halved over the past three years, from 1.8 per cent to 1 per cent.

A: Good on you for cutting your rate, which was pretty reasonable to start with. You have given me permission to name your agency, which is Domett Real Estate.

I received several interesting emails about real estate commissions. More on this next week, too.

Insurance? I give up

Q: I’ve given up on house insurance. If the worst conceivable event left me with a pile of rubble, I would still own a residential section, with all services connected and somewhere to park a mobile residence.

Part of my savings would buy a motorhome. I could choose to live a roaming life like many in New Zealand already choose. An enriching life experience. And I’d probably still be left with enough to establish another more modest residence if necessary. Another life project.

For me, battling a company who is adept at payout avoidance could be as traumatic as the loss of my possessions and personal “treasures” that cannot be replaced anyway.

I’ll be my own insurer, and take it as it comes, and I’ll know where I stand straight after any event.

A: In an earthquake, eruption, flood, landslide or tsunami you might have to pay for reconnections and expenses to fix the land and remove rubble. And your land value might plummet.

Still, it sounds as if you would manage. So good on you. The measure of a person’s need for insurance is how well they would cope without it.

– Mary Holm, ONZM, is a freelance journalist, a seminar presenter and a bestselling author on personal finance. She is a director of Financial Services Complaints Ltd (FSCL) and a former director of the Financial Markets Authority. Her opinions do not reflect the position of any organisation in which she holds office. Mary’s advice is of a general nature, and she is not responsible for any loss that any reader may suffer from following it. Send questions to [email protected]. Letters should not exceed 200 words. We won’t publish your name. Please provide a (preferably daytime) phone number. Unfortunately, Mary cannot answer all questions, correspond directly with readers, or give financial advice.

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