Could the Cash Fund outperform Defensive?

Generally, people invest in bonds because they tend to be defensive assets that support portfolio returns and cash flow requirements when risky assets lose value. With bonds, simply put, being loans to governments and corporations for which investors receive interest repayments, a misconception is that bonds can’t lose money. While bonds are generally considered to be less risky than most other asset classes, they do have risks associated with them that can cause them to deliver negative returns. The value of bonds can rise or fall depending on interest rates, the credit rating of the bond issuer and the economy.

The primary risk that bonds are exposed to is an increase in interest rates. When interest rates go up, existing bonds lose value (i.e. bond prices are inversely correlated to interest rates). This is because the existing bond has ‘locked in’ a lower interest rate (yield) than what is available in the market for any newly issued bonds.

When central banks around the world (such as the Federal Reserve in the US) cut interest rates – as they have been doing since the Global Financial Crisis – bond returns get a boost. On the other hand, interest rate rises which are expected by investors over the coming years can have a negative impact on bond returns in the Defensive Fund.

In contrast, the short term cash investments made by the Cash Fund are not negatively impacted by increasing interest rates and therefore have the potential to outperform the Defensive Fund over short periods where interest rates rise faster than expected. Over the long term however, bonds, and therefore the Defensive Fund, are expected to outperform cash as investors tend to be compensated for the additional risk they are holding.

Want to know more? For more information on the Scheme call 0508 intandem (0508 468 263) or visit westpacintandem.co.nz