There is a sense of nervousness in the markets, which has been exacerbated by yet another finance company collapse. It's as if we are teetering on the brink of what could be a sudden change in investment markets. That's not necessarily bad news, however.

The four different categories of investment (cash, fixed interest, property and shares) respond differently to changes in the economic environment and no matter what happens, there will always be at least one that does well. Right now, the best returns will be had from cash, short term fixed interest investments, mortgage backed investments and good quality finance company debentures.

Investors in bonds or in bond funds are seeing the market value of their investments decline as interest rates continue to rise. This phenomenon is not very well understood by some investors.  A bond is issued by a large company in order to raise money directly from the public or institutional investors. It has a face value (say $10,000), a maturity date (say five years) and a fixed rate of interest, called the coupon rate. If a bond is issued with a coupon of 8% and market interest rates rise, then the market value of the bond falls, as it is less attractive than other market alternatives. The longer it is until the bond matures, the more volatile the value of the bond will be. As the bond approaches maturity, its market value approaches its face value. Bonds can also fall in value if the market perceives there is an increased risk of a default in the payment of either interest or capital. Bond funds are managed funds which invest in a number of different bonds in order to spread risk. Investors or fund managers who have significant holdings in bonds are investing in quality short dated bonds so as to lessen the impact of the rise in interest rates.

Interest rates are likely to stay high for some months, but once they start falling, they could drop quite quickly. The tables will turn. Cash and short term fixed interest investments will become less attractive and long dated bonds will rise in value.

Try and pick the time when this change will occur and you will probably get it wrong. Investors in international shares who have been taking advantage of the high exchange rate to buy cheaply offshore now face a similar dilemma and are playing a waiting game. A sharp drop in the value of the dollar, which could occur at any time (the sooner the better, the exporters would say), will most likely flow through to an increase in the value of offshore investments, rewarding those who have the patience to wait.

There is perhaps a little more certainty with property investment. On the residential front, Mr Bollard has made it quite clear he will do whatever is necessary to halt the increase in property prices. Any investor increasing their exposure to residential property now will be doing so with the view that they will hold their investments over the long term and make their returns in the next property cycle. Commercial and industrial property investors will also be taking a long term view, as in the short term, a slowdown in economic growth will flow through to this sector. With so much uncertainty in the markets at present, your best investment strategy is to be patient, look for quality in your investments and spread your risk by investing in all categories and within each category into a number of different investments.

Article by Liz Koh

Liz Koh is a financial adviser. A copy of her disclosure statement can be obtained on request and free of charge by calling 0800 273 847.

Ph 0800 273 847

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