When and How to Choose Fixed vs Floating Rate Investments

In normal times, Amicus has a bias towards recommending floating rate over fixed rate notes to its clients.  This is because with a floating rate note there is no interest rate risk meaning that unless the issuer defaults (low risk) then clients are guaranteed a set margin over the BBSW rate.  The BBSW rate is closely linked to the Bloomberg Bank Bill Index (a common benchmark for most investors) so the coupon margin essentially guarantees the investor out-performance over benchmark assuming the investment is held to maturity.  Further because there is no interest rate risk, the notes will also more likely trade at around a par price so if they need to be sold for liquidity reasons (not as a first option, but as a contingency) then there is unlikely to be a capital loss.  However, these are not normal times!

The RBA has taken the unusual step of clearly enunciating it does not intend to raise interest rates until 2024.  It has also provided a sound fundamental rationale for this policy being it does not forecast inflation to be back within its target zone until this time as there are currently no signs of inflationary pressures within the Australian economy.  This allows Amicus to predict with some certainty that short term interest rates will be largely unchanged over at least the next two years.

In deciding whether to recommend the fixed or floating rate option to its clients when Bank of Queensland came to the market last month trying to raise five year funds, Amicus performed the scenario analysis summarised below as part of its overall advice to clients in determining which note was likely to provide the greatest overall return to investors over the life of the security:

Due to the shape of the yield curve at the time Amicus concluded the fixed rate note would likely offer higher returns which was a factor to consider in the overall investment decision to be weighed against the other factors listed above and further considerations of boosting overall portfolio yields now as opposed to in the future.

Amicus encourages investors to contact us if they would like to discuss the basis of our scenario analysis and other considerations relevant to making the decision in choosing a fixed or floating rate payment option.

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