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For the last 3 years, SuperLife has suggested to members where they have wanted a conservative strategy and are more interested in the 1-year return than the 1-month return, that they should favour bonds over cash. We expected overseas bonds to have a higher, but more volatile, return than NZ bonds and so focused on NZ bonds over cash for investors wanting a conservative portfolio. We continue to suggest bonds over cash and expect to for the next year, but recognise that there will come a time when the cash Pool again becomes the "safer" 1-year return option.

Over the last three years to 31 August 2012, the after-tax and fees return from the cash Pool was 2.8% a year. This compares to 6.2% a year for NZ bonds. These are after-tax at 28% and after fees. The different 1-year net returns1 for the cash and NZ bond Pools over this period have been:

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Chart 1 shows that over each 1-year period, the NZ bond return has been higher than the return from cash but more variable. Also, during this time, NZ bonds did not outperform cash in each month. Chart 2 shows that the monthly returns from cash were quite stable (around 0.25% a month), relative to the NZ bond returns which varied from -1.5% to +1.25%.

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It is also important to note that while annual returns have been higher over the last 3 years, this has not always been the case. In the last ten years, New Zealand has quite often experienced cash returns above what was achieved in the bond market. This was particularly the case between October 2004 and 2008 - see chart 3.

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Charts 2 and 3 highlight the importance for each investor to understand their investment time horizon and when they will spend their savings. If an investor expects to spend their savings in the near future, then chasing the expected, but not guaranteed, higher bond return may not be the best option. Investors who do, may end up selling the bonds in the "bad" month. Bonds are generally only suitable (give a positive average return) if the horizon time is at least 1 to 2 years.

The outlook

In terms of the next 12 months, the likely return for the cash pool will be driven by the current short-term interest rates (i.e. 2.65%) less tax. In contrast, the return from bonds depends not only on the current bond yields (3.65% for ten years) but also on how these change over the year. If bond yields fall, the value of the bonds rises, giving a higher return. Likewise, if bond yields rise, the value of the bonds goes down. This capital gain/loss is added to the current yield to give the total return.

Over the last few years, bond yields have fallen, creating gains which have resulted in very good returns from bonds being experienced. But yields can only fall so far.

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We do not expect bond yields to fall much further and so the chance of future returns being as high in the immediate future as in the recent past, is low. However, we still expect bonds to outperform cash over the next year but, like in the past, not in every month.

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Footnote

1. The net return is the return net-of-tax at 28% (the top PIR rate) and net-of-investment and asset related fees.

Legal stuff

The above article is a general investment commentary. It should not be considered as being personalised investment advice. Members should obtain appropriate financial advice from a suitably experienced Authorised Financial Advisor before making any investment decisions. Only an Authorised Financial Advisor can legally take into account the member's personal circumstances. SuperLife does not give personalised financial advice.