8th April 2009
When money in the bank is outperformed by fixed interest investments
The Reserve Bank of Australia at its April meeting yesterday reduced the official cash rate by 0.25% taking some more of the shine off online savings accounts and term deposits. In contrast, it is already confirmed that banks are partly or completely withholding this reduction from mortgage borrowers. This sets the benchmark for the whole mortgage investment industry and indicates banks' potential intent through this final reduction phase of the interest rate cycle.
And it is not expected that the official cash rate will stay where it is for long. If and when the official cash rate does go lower, even the most conservative of investors are expected to start looking around for higher rates of return, albeit towards the other end of the risk spectrum, moving up the risk pole, through fixed income and bond funds, mortgage funds to equities.
Shane Oliver, AMP Capital Investors' Head of Investment Strategy and Chief Economist, says the most likely place for cash investors looking for a reasonable rate of return with little or no risk will be in the asset category loosely called 'fixed interest' investments including cash funds and bond funds (with variable rates). Then, those investors seeking higher and more stable rates in the form of regular income, and yet seeking to stay within the fixed income type asset class, will look to mortgage funds. Finally, as confidence is restored, investors will cautiously re-enter the equities market.
Time for Defence
Investors have been defensive because of the uncertainties surrounding the economy and the investment markets. Oliver says that the latest data from the Australian Bureau of Statistics which show household savings at their highest rate since the last recession demonstrates that investors are motivated by being defensive rather than by looking for returns. "Most of the savings are precautionary should people lose their job. People are being defensive. There will be a time when people are motivated by returns again especially as the cash rate gets lower and lower," says Oliver. Oliver is predicting the official cash rate to reach 1.5 per cent in the second half of 2009 which means term deposits will return about 2.5 per cent.
When returns on term deposits fall to this level, investors will look to other investments to generate a higher return consistent with the risk that they are prepared to take.
Moving up the risk pole
As economic conditions stabilise and investors gain more confidence, they will be inclined to 'move up the risk pole'.
The first step up from term deposits are bond funds. Darren Langer, head of portfolio management at Tyndall/Suncorp Investment Management is expecting bond funds to return between 4.5% and 6% in 2009, depending on how corporate bonds perform in the current environment. He expects the best returns to come from Australian-dominated bond funds with allocations to Government, semi-government and corporate issues. IPAC Securities Jeff Rogers says if the economy eventually stabilises, Government bond yields would start to increase, and returns will come down, making the riskier corporate bond sector a source of better returns.
Investors seeking higher risk-adjusted returns will start to look at mortgage funds. In particular however, mortgages are also now effectively 'outperforming' on risk-adjusted investment returns as official cash rate reductions are not passed on to borrowers by banks and mortgage funds. Paul Wells, Head of Funding and Strategy at La Trobe is expecting that mortgage funds will continue to deliver returns that are above bond funds, between 5% and 7% in 2009.
Notwithstanding liquidity issues with many mortgage funds in 2008 and continuing, mortgage funds play an important part in the provision of credit, particularly in the commercial sector, and are likely to be in a position to generate good returns.
Mr Wells believes that properly managed mortgage funds that better match asset and liability maturities have proven their investment model by not 'freezing' redemptions and are now enjoying considerable success by having funds available when most competitors do not: resulting in quality deal flow with relatively high returns. Mr Wells noted that the La Trobe Australian Mortgage Fund was one of the few mortgage funds to be unaffected by the liquidity issues of last year, and its Pooled Mortgages Option is currently returning 6.95%1, well above the bank bill index and having reduced only 1.30% in the period that official cash rates have now declined 4.25%.
In a final note, we re-affirm La Trobe's view that investors should always obtain professional advice in deciding on their investment strategies and they should always consider the risks, as well as the returns, in making investment decisions.
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Head of Funds Management
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Chris Andrews is the Head of Funds Management for the La Trobe Group and has responsibility for the La Trobe Australian Mortgage Fund.
Read full profile here.
La Trobe is one of Australia's leading independent specialist mortgage Financiers. Its business includes residential mortgages, commercial mortgages, and investment services operating one of Australia's largest Mortgage Funds under AFSL 222213. It employs over 115 staff and has raised over AUD$10Billion to assist over 100,000 customers since inception in 1952.
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