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Securing a balanced portfolio

DEBT securities are gaining prominence as investors look for secure investments in the current volatile equity market, but the drop in interest rates is undermining the attractiveness of this form of securities.

Stockbroking firm DJ Carmichael advises that investing in securities as part of a balanced portfolio is particularly important in a bear market, when equity prices are falling, as has been the case for the past two months.

UWA economic associate professor Nic Groenewold believes investors always tend to look to debt securities when the equity market is over-valued.

“If you go back before September 11, you will see that the stockmarket was overvalued in Australia at least 10 per cent and in the US probably about 20 per cent,” Dr Groenewold said.

“In those situations people tend to look more toward debt securities. My feeling is that it was just waiting for something to set it off.

“When people start getting jittery they tend to move toward debt security and that of course pushes the price of debt up and the yield on that debt down until it is no longer attractive.”

Debt securities come in a variety of forms, including convertible or redeemable notes, floating rate notes, bonds and debentures as well as preference shares.

A convertible note is usually issued for a fixed period at a fixed rate of interest based on its issue price or the coupon rate.

The note holder has the right to convert the note to ordinary shares at a pre-determined date or to redeem the note for cash for its initial face value issue price.

Floating notes are listed, perpetual debt, where the interest rate floats at a margin above the 90-day bank bill rate, that is adjusted quarterly.

The attractiveness of floating notes is eroded, however, every time there is a fall in commercial interest rates. The current low interest rate environment is bad news for debt securities, as Paterson Ord Minnett Ltd head of research Greg Galton points out.

“Anything that is linked to short-term rates will mean the yield could be very low. The drop in interest rates makes debt securities less attractive,” he said.

“If you look at the US, for example, the decrease in interest rates is all about making the equity market more attractive while making debt security less attractive.”

Mr Galton believes that the equity market still provides good opportunities for investors.

“I think you have seen most of the risk already factored in the equity prices,” he said. “If you haven’t yet bought debt securities it is already too late.”

While the drop in interest rates may nullify the attractiveness of debt securities, high profile company collapses and the possibility of more to follow still provide a good argument for holding on to debt securities.

“The interest rate return is known and debt holders will be in the front of the queue when a company falls over,” Dr Groenewold said.

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