Charles Wall
Retail investors should be avoiding fixed interest investments that are complex and leveraged, Putnam Investments Australia senior vice-president Charles Wall warns.
“Complexity and leverage are dangerous things for a retail investor,” Wall said.
“The message investors must understand with fixed interest is keep it simple.”
Wall said complexity was brought into fixed interest because managers wanted to gain some extra return above using traditional bonds.
“There has been a big sea change in fixed interest in recent years,” he said.
“It was like the change that happened to property trusts 15 years ago.”
Wall said the fixed interest sector had witnessed an explosion of derivatives, which managers were using to gain beta returns.
This added complexity to fixed interest and greater risk, especially when mortgage-backed investments were added to the melting pot.
Wall said the tightening of credit and the repricing of this debt was causing problems at a number of blue chip financial services companies.
“The securitisation of investments such as mortgages is not bad and institutional investors understood the risks and the returns,” he said.
“But people have gotten lazy and have not been looking at the underlying investments, and these products were then sold to retail investors who didn’t understand what they were getting into.”
Retail leveraged fixed interest products were not necessarily bad as long as they had the ability to withstand shocks to the financial services system, Wall said.
“The lesson from this is that if leverage is used carefully and wisely, then the risks are reduced,” he said.
“The more complex the leverage, then it is less simple for investors and the risks won’t be understood.”
Wall said sub-prime mortgages were inappropriate investments to be leveraged into retail products such as collateralised debt obligations (CDO).
He agreed some people had forgotten the difference between mortgage funds where there is always inherent risk of people defaulting and fixed interest funds with corporate and government bonds.
“The reoccurring message to retail investors is keep it simple and look at the underlying assets in the CDO before investing,” Wall said.
