Over the last five years, Australian investors have seen a significant fall in the returns on their cash and term deposit holdings, and in many cases are experiencing negative real returns for the first time. This has created financial stress for many clients, especially retirees who may need to draw on their capital in the short term to maintain their lifestyle.
When we explore the behaviour of self-managed super fund investors – both advised and non-advised – we find that the majority of funds are rolled on a 90- to 180-day basis. This shows that investors either:
1. believe that interest rates have been bottoming for the past several years, so they keep their maturities short to catch the rate rises, and are using the deposit like a floating rate note
2. are parking the funds for the short term while they wait for other opportunities, so they are less sensitive to returns and are possibly not using an authentic portfolio asset allocation strategy. If these client have not found any suitable opportunities by now, they will likely be experiencing diminishing returns on their capital.
The key factor in managing interest rate exposure is to assess the client’s investment horizon. Pinpointing the horizon makes it possible to determine the appropriate vehicle, but the challenge for advisers and their clients lies in arriving at a view on interest rate movements.
If rates are likely to fall for the duration of the client’s investment, or if the client wants to park their funds while waiting for other investment opportunities, then a term deposit is likely to be the best option as it will protect the client’s returns as rates fall.
On the other hand, if rates are likely to rise, or to remain stable in the short term before rising, then a floating investment is more appropriate, as it will allow the client to benefit as rates rise.
The Commonwealth Bank’s Deposit Plus product enables advisers to lock in their view on interest rates, either fixed or floating, as required. This gives the client two advantages: certainty of their return during the fixed term, and a guaranteed benefit from any increase in interest rates (based on the three-month Bank Bill Swap Rate) during floating periods.
For advisers, this product offers additional benefits. Deposits and interest rate risk management can become a more formal component of the strategy conversation, which can add significant value to a client. Furthermore, the practice need not perform an ever-increasing series of short-term deposit roll-overs throughout the year.
