Many fixed income investments have a predefined maturity date. When making the investment, the date is stated in the contract and known by the investor. There are also some investments which may have embedded clauses to allow the issuer of the investment to repay investors early. This is known as a “call feature”. The details of the criteria or circumstances which allow the issuer to call the investment, along with the dates when the call feature can be exercised, are stated in these types of investments. Whether your fixed income investment has a fixed maturity date or is callable, it is important to start to look for reinvestment options close to the maturity/call dates.
For investments that mature or are called, the investor faces reinvestment risk. The question in the mind of the investor is now, “Where do I invest the funds received from my previous investment?” Having been comfortable with the returns and the risk level of the previous investment, ideally we would want to reinvest in an instrument with similar (or better) risk and reward characteristics. However, it is important to understand that with changes in market conditions and global economic conditions, the risk/reward dynamic of the investment options currently available may be vastly different from when we made the previous investment. Interest rates may have declined since, and the investor is now faced with two scenarios:
1. Take on more risk for the same level of return (interest)
2. Accept lower returns from investments which meet their risk appetite
A call feature is very likely to be executed in a time of reduced interest rates as the issuer can repay the current instrument and raise capital at lower rates. This makes callable instruments highly susceptible to reinvestment risk. Conversely, if interest rates have increased, then the investor will gladly take the proceeds from a maturity or call and reinvest, as they are now able to get higher returns without having to take on more risk.
Recently the Government of Jamaica (GOJ) 11.625% 2022 US$ global bond matured. Many investors are now left with the task of determining how to reinvest the proceeds. To earn 11% in today's low interest rate market, the investor now must look for “high risk” investments to achieve this. Interest rates have fallen since those GOJ bonds were previously issued. The investor will now have to accept lower interest rates or take on greater risk. When reinvesting, compare the new investment options to the previous investment by analysing both the risk and the returns (interest rate). By only looking at the interest rates, you may be investing in an instrument which is outside your risk appetite.
Make sure that you understand how the markets have changed since your previous investment, analyse what is available and choose the best available, investment that meets your risk appetite. As always, consult with your licensed financial advisor.
Dwayne Neil, MBA, is the AVP, personal financial planning at Sterling Asset Management. Sterling provides financial advice and instruments in US dollars and other hard currencies to the corporate, individual, and institutional investor. Visit our website at www.sterling.com.jm Feedback: if you wish to have Sterling address your investment questions in upcoming articles, e-mail us at firstname.lastname@example.org.