By Santhiran Naidoo, 3 February 2014
This followed a sustained period of interest rate decreases which saw interest rates fall to multi-decade lows. Consumers generally have debt obligations such as house and car bonds or even shorter term loans and have been aided by the declining cost of their debt. South African consumers have therefore reacted negatively to the announcement that sees an increase in the cost of their debt. Retirees, on the other hand, are generally free from these obligations, so the impact of rising interest rates has usually been somewhat different for them.
Traditionally, retirees have been invested in safer, low duration fixed interest investments such as money market funds or shorter term bond funds. This has provided investors with relatively low risk investments. In a rising interest rate environment, instruments that yield higher levels of income become available. This would boost the yield that retirees receive from their investments.
However, as the industry has evolved, education around personal risk profiling and diversification has advanced. This has seen retirees shift their exposure from these low duration fixed interest investments into more diversified portfolios consisting of riskier growth assets such as equities and property as well as longer duration fixed interest investments.
Rising interest rates generally impact these riskier asset classes negatively. Longer duration bonds experience capital losses while property prices decline as the cost of debt to finance development and purchases increases. The effect on equities is less clear. In instances where interest rates are increasing due to an improving economy or to control modest inflation, companies may be able to sustain growth and/or pass through those inflationary pressures to consumers. However, if rates increase in a poorly performing economy, the cost of debt may significantly impact the profitability of companies.
So while in the past an interest rate hike would have been positive for retirees, the impact on their investments today is less clear given that there has been a shift to more diversified portfolios.