Investments for the sinking fund of a Body Corporate
Before we get started, it’s important to seek independent legal advice as to the investments and the structure required for Body Corporates to invest in anything other than cash. At Solace Financial we have access to Body Corporate legal specialists that can assist here.
As a treasure of a Body Corporate myself, I’m mostly concerned about the real negative returns (after inflation) that sinking funds are producing for lot owners.
There are two separate approaches I look at when considering improving the investment returns of sinking funds for Body Corporates:
“Do better than Term Deposits but keep it safe Scott.”
We can use Government and Corporate bonds to increase the return of the sinking fund while keeping risk low.
But what is a Government or Corporate bond?
- A bond is a document, describing a loan that has been made to a company or government.
- A bond is a lot like a Term Deposit. A bond comes with an interest rate that needs to be paid over a certain period.
- Unlike a Term Deposit, Bonds are tradeable. They can be sold to other investors during their Term.
- Multiple people or investors can pool their money to purchase a bond.
- Bonds are valued every day.
Suppose that Qantas wanted to buy a new Jumbo Jet for $1m. Instead of going to the bank to get a loan, they could issue a bond. Several investors could pool their money to purchase this bond, effectively loaning Qantas $1m. The bond could have an interest rate of 6% pa and have a term of 2 years. Which would mean that Qantas would need to pay the investors 6% of $1m per year and at the end of 2 years fully repay the $1m.
- Like a term deposit, there are risks.
- What if the bank you have your term deposit in goes bankrupt? What if Qantas were to go bankrupt? Then the money in your Term deposit or Qantas bond would be lost.
- What if interest rates go up? Your Term Deposit would be locked until the end of your term. While everyone else was getting a higher interest rate on their new Term Deposits. This is the same with Bonds. If the Term on your Qantas bond was 2 years at 6% and the month after you purchased your Qantas bond interest rates went up to 7%, you would be stuck only earning 6% for the next 2 years.
- Company risk. Before the pandemic, Qantas looked like a reasonably safe company. But during the pandemic, Qantas was considered a risky company. Borrowing money during the pandemic by issuing bonds meant that Qantas needed to offer a higher interest rate to attract investors, even though the government interest rate stayed the same.
- If all of your money was in a Qantas bond and they went bust, you would lose all of your money. But if you spread your money out evenly over 100 different company bonds and Qantas went bust, then you would only lose 1% of your money, instead of 100%.
- Having very short terms on your bonds will reduce the risk to the current value if interest rates were to go up. You could simply wait until your bond matures, then get a new one at a higher interest rate. This is a simplified explanation of Duration risk.
- Only purchase bonds in large and highly stable governments and companies. For example, the QLD state government currently offers bonds and it’s unlikely that the QLD government will go bankrupt. But they may not pay a very high-interest rate.
“Scott, plan for the future. Make us a good return but make sure we are never left short”
We work off the sinking funds’ depreciation schedule of the Body Corporate and break this up into three categories. We have different investments for each of the categories which have different return objectives and risks.
- Short-term expenses: Any expenses that are due within 5 years
- Medium-term expenses: Anything due in between 5-10 years
- Longer-term expenses: Expenses due in more than 10 years.
Short-term expenses, we keep very safe, Conservative. We are aiming for a return of inflation of +2% over a rolling 2-year period. The investment mix is generally 80% Fixed Interest and 20% shares.
For medium-term expenses, we invest in a Moderate way. We aim for a return of inflation +4% over a rolling 5-year period. The investment mix is generally 40% Fixed Interest and 60% shares.
Longer term expenses, we invest for Growth. We aim for a return of inflation +5.5% over a rolling 7-year period. The investment mix is generally 100% shares.
This way, if the body corporate needed the property repainted in 2 years and there was a big fall in the share market, the money could be taken from the conservative investment which may not be as affected by a share market fall.
Frequently Answered Questions
Q: Can you answer questions and provide presentations to the group?
A: Yes. I can attend meetings and provide presentations on the returns and volatility. There are no costs for this if it’s over Zoom or Teams, there is a call-out fee if I need to meet with owners on site.
Q: How would the investment be set up?
A: We prepare a statement of advice putting forward our recommendations to present to the group to read and decide on. Once accepted, we will prepare the structure and forms to invest the funds.
Q: How can I see how the investment is performing?
A: Select members of the Body Corporate will have online access, where they can run reports on transactions, performance, etc (Or call me). Transactions need to be signed by the Body Corporate manager and sent through our office.
Q: If I needed funds immediately, how long would it take to receive them?
A: The underlying funds used are highly liquid in all market conditions – generally, redemptions can take about ten (10) business days.
Q: What are the setup costs and ongoing costs?
A: The setup fee is $3,300 which covers our costs. We also receive 0.88% of the investment balance yearly. The returns I have talked about are net of fees.
Q: What if Solace goes broke?
A: None of your money is ever held by Solace Financial. The funds are held by about 20 different investment managers, similar to a normal super fund. You could contact the funds directly and sign their paperwork if required.