Is the dream run for term deposits about to end?
The popularity of term deposits is currently so high that other product providers need to fight for a little bit of airspace. But is it just a matter of time until term deposits go from boom to doom?
Term deposits used to be a vehicle for wealthy individuals and the older generations to park a bit of cash. But this all changed in 2008 when the markets dipped and most investors fled to safety.
Today, term deposits are arguably one of the most popular products out there and have become a permanent part of investors’ portfolios.
In fact, investors old and young now use this product as an important part of their medium-to-long-term investment strategy.
This massive shift in how cash is used in a portfolio has made term deposits boom.
There are approximately 10 million term deposit accounts in Australia with a combined worth of more than $725 billion, according to figures from comparison website RateCity.
Australian Unity investment head David Bryant agrees that there has been a fundamental shift in the way people use term deposits.
“Saving and investing, which used to be quite separate, have very much converged,” he says.
But the public attitude to cash and term deposits has a lot do with changing ideas about investment, RaboDirect investment manager Tim Hewson said.
Most money invested in term deposits is what would have normally been invested in growth assets, but clients no longer feel comfortable allocating funds into the equity market, Hewson says.
His comments are backed by figures which came out of Investment Trends' 2011 Adviser Product Needs Report.
The average planner has estimated in late 2011 that their clients hold a combined amount of $3.9 million in excess cash.
This same trend tells the industry that the high allocations to term deposits are here to stay, Hewson says.
Financial advisers are increasing the flow of money into term deposits.
Nearly 58 per cent of the money coming into Rabobank’s term deposits is from intermediaries like financial planners, while 38 per cent comes directly from retail investors.
PIMCO head of global wealth management Peter Dorrian believes the shift is a flight from volatility rather than a structural change.
Investors – particularly retiring investors – fear what is going on in the Northern Hemisphere, and the general level of volatility in markets, he says.
The feedback from AMP's distribution networks is that people are searching for any product that can give them some return, says director of platforms Steve Burgess.
“Until the market sorts itself out, people are looking for a cash bolthole that can give them that,” he says.
An investor’s savings and investment pattern is shaped by their early experiences.
A generation that has done well out of property investment will have their beliefs in that sector reinforced by their experience.
Similarly, those investors who have lived through a boom in the share market will believe in the ability of the market to generate returns.
But investors who have gone through the credit crunch and seen their healthy investment portfolios deteriorate, without the ability to regenerate their wealth, will avoid investing in the share market once more and simply hold on to their money.
The swing to a more conservative investment position as investors move into retirement is likely to become much more pronounced than usual, Bryant says.
“This is the group that is most at risk, by actually being too long on cash, because if you look at that group that is approaching 60, they suffered the most, and at a time when they didn’t have the capacity to recoup it.”
Inequality
Not all term deposits are equal. Around 90 per cent of them have a term of less than
12 months, according to figures quoted by the director of banking research and analysis firm RFi, Alan Shield.
A breakup of Rabobank’s total term deposits portfolio shows nearly 63 per cent of all their inflows are going to term deposits of one year or less.
Forty-two per cent of that is in a term deposit of less than 12 months. Another 23 per cent of inflows are going towards term deposits of five years.
The rest of their inflows go towards two, three and four deposits.
Hewson uses those five-year figures as proof of the structural change towards cash investing in the long-term.
It is most prevalent within their self-managed superannuation fund (SMSF) customer base, which is a reasonably large proportion of their total term deposit book, he says.
“That shift is not simply about liquidity, it’s not simply about sitting on the sidelines and waiting for a better opportunity, it is now more about where does cash fit in the portfolio, what role does it play, how do you allocate, and what is the purpose of that allocation,” he says.
Shield claims there is no material difference in many cases between the average interest rates on a six-month, 12-month, or five-year deposit.
That might suggest there is no financial incentive driving investors to squirrel away money for long periods of time, and could prove Hewson’s theory that changing investment behaviour is behind the shift to term deposits.
However, an analysis of the term deposits being offered currently by the big four banks shows a clear disparity between short-term and longer-term term deposits.
The Commonwealth Bank's interest rate for a five-year term deposit is 5.1 per cent per annum, compared to 4.4 per cent for an
11-month or five-month term deposit. The interest rate also jumps by 10 basis points if more money goes into the term deposit. ANZ is offering 5 per cent for five years, and 4.5 per cent for six and 12 months.
NAB is also offering 5 per cent interest for five years, and 4.55 per cent for six months, while Westpac is offering 5.2 per cent for five years and 4.5 per cent for six months.
The interest rate Rabobank itself encourages investors to put their money away for long periods of time.
The rate on a six-month and one-year term deposit is 4.6 per cent and 4.7 per cent respectively on an annual paid interest deposit of more than $50,000, while a five-year term deposit will earn 5.2 per cent under the same conditions.
On a $100,000 five-year deposit, that would equate to nearly $29,000 in compounded interest, compared to more than $25,000 on a one-year rolling term deposit.
Platforms and product providers
Product providers and platforms are laughing all the way to the bank. Canstar Cannex’s superannuation star ratings found that four out of the 11 funds rated as five stars by the company – all retail funds – were offering term deposits to investors.
Colonial First State's FirstChoice Personal Super, Sunsuper, AMP’s suite of flexible super products, and MLC have all introduced the product.
Canstar research manager Chris Groth said term deposits were a popular option among SMSFs, but were now being offered across all super funds.
Macquarie Bank announced in July that it was upgrading the functionality of its term deposits for SMSF investors, streamlining administration through data feed improvements and an online maturities capability.
“Managing term deposit maturities can be a laborious process for both advisers and their clients, with the traditional process requiring significant paperwork,” Macquarie Adviser Services head of cash product Peter Forrest said.
Cash and term deposits held with ING Direct also have no fees.
“I only have to go back four years, and things like term deposits did not exist on platforms for investors and advisers, and now, you couldn’t find a platform without it,” Bryant said.
The funds are coming in in a rush. One of PIMCO’s clients introduced term deposits on their platform 18 months ago. Those assets are now worth between $1 billion and $1.5 billion.
“It’s a fantastic source of funding for the banks,” Dorrian says.
AMP recently announced it would rebate term deposit administration fees on its North platform until the end of the year.
Figures provided by AMP show inflows into term deposit products on North over the past 12 months to July have reached 25 per cent. Only multi-manager funds have averaged more over that same period.
Term deposits make up just over 13 per cent of funds under advice on the platform.
AMP, ANZ, Westpac and Adelaide Bank all offer the product on North. Term deposits were introduced onto the platform in April last year.
There are over 100 term deposits offered by just the institutional players. Part of the reason for the fierce competition is the dry up in funding from the global financial crisis (GFC).
Because the banks were scrabbling for funding in the domestic market to offset higher interest rates on overseas funding, they are willing to pay a premium on term deposits compared to the cash rate of 3.5 per cent.
Before the GFC, the difference between the cash rate and the term deposit rate of 5 per cent would have been much smaller, Shield says.
Competitive pressure prevents any of the product providers from dropping their term deposit rate, he says.
Competition between the platforms and the smaller banks for term deposits is fierce.
Platforms don’t offer the wide choice of cash solutions to advisers that they can find at a small bank, Hewson says.
Administration fees, inflation and adviser fees all eat into the returns, he adds.
“One of the many reasons we’ve done so well in the intermediary market is because advisers come to us because they’re looking for a better deal for their customers,” Hewson says.
Burgess rejects suggestions that platform fees are eating away returns for investors. North’s administration fees are around 0.6 per cent on average.
Part of the rebating of the administration fee is to first entice new investors on to the platform, then induce them to try other products, he says.
“The rationale behind the rebate is that once they’re on North, within the term deposit, and then they – in conjunction with the financial adviser – want to start investing again in growth assets, well they’re already on the platform,” Burgess says.
The platform also offers consolidated reporting and access to a wide range of investments, he says.
Term deposits versus the rest
The cash sector is in a bruising battle for savings at the moment, and the term deposit industry is fighting to overpower its rivals.
According to Shield, nearly one in five people have a term deposit, but two-thirds of people have some kind of high online savings account.
At the moment, high online savings accounts offer better interest rates, but they can’t offer a guaranteed return for a certain period of time. The market is still factoring in the potential for interest rate cuts later this year.
Recent investigations of the high interest savings accounts on offer found the best rate was being offered by National Australia Bank subsidiary UBank, at 5.71 per cent per year, provided the customer put money into the account every month.
The next one on offer is RaboDirect, at 5.6 per cent for the first four months, after which it drops to 4.6 per cent.
Most term deposits are around 5 per cent for a six-month deposit.
While Shield concedes that savers are probably better off in the high interest savings account, he says that because term deposits offer institutional backing, they only have to be competitive and not the best.
Term deposits holders want stability before interest, Shield says.
A high online savings account is a different beast, Hewson says.
“A lot of the questions we get are around the four-month period and the six-month period and how that compares to term deposits, and of course it doesn’t – you’re talking about cash products with slightly different behaviours and features,” he says.
Product providers should encourage advisers to speak to their younger clients if they want to gain the edge in the cash battle.
A Sunsuper survey found that 68 per cent of Generation Y’s were more likely to put their money in a savings account rather than a term deposit.
Twenty-six per cent of Baby Boomers were likely to put their money into term deposits, and 15 per cent were likely to put their savings into shares.
Sunsuper general manager of customer experience Teifi Whatley surmised that Gen Y had less experience with term deposits and a greater need to access their money.
Advisers, other products struggling for airspace
The huge growth in term deposits has left the rest of the industry struggling to make their voices heard.
In May this year, Charter Hall property fund chief executive Richard Stacker said industrial property was a good alternative to term deposits.
Property still fills a need for diversification and performed well compared to other sectors, he said. Around 70 to 80 per cent of total returns came from yield, with the remaining part coming from increases in underlying leases.
Stacker also called for advisers to be educated about the benefits of property.
Interest rate cuts will make term deposits less attractive to investors, he said.
Fixed interest is another sector that has fallen by the wayside. Fixed interest funds returned approximately 12 per cent last year, compared to term deposits at a cash rate of about 5 per cent.
The elephant in the room is share market growth. An investor who had bought $10,000 worth of CBA shares in June 2008 would now have a portfolio worth more than $18,800, including franking credits.
The same amount of money in a term deposit would have earned $2,500 interest over the same period, according to Australian Unity.
“Investors have become very singular in what they’re comfortable with,” Bryant says.
Bryant believes the shift to cash has moved too far in the wrong direction. Instead of cash being a more meaningful part of a portfolio, it has become the portfolio itself.
All the benefits that term deposits brought in the past, like certainty of capital, access to cash at certain points, and predictable income have overridden more important objectives of providing long-term for retirement.
If investors lock money away in a term deposit, they will deny themselves the opportunity of capital growth in the bond market if economic circumstances deteriorate further, and interest rates drop, Dorrian says.
“Term deposits do offer, to the layman, a very appropriate and worthy component of a portfolio, but it shouldn’t be the only component of a portfolio,” he says.
Bryant believes advisers are giving in to their client’s fear about the state of the share market.
Most advisers believe Australia has hit the bottom of the equity and property market, and believe the time has come to move out of cash, but they can’t convince their clients of that.
That struggle is beginning to show up in industry figures.
Investment Trends found that despite that amount of money being ploughed into term deposits, planners expect the market to return around 5 per cent to a portfolio.
Their clients expect the market to return only 3 per cent – less than the returns expected from term deposits.
“There is a generational shaping here – that experience [of the GFC] will not be forgotten,” Bryant says.
Is the time up for term deposits?
Rabobank has been pushing SMSF trustees to lock money in a term deposit before the Reserve Bank of Australia (RBA) again drops its interest rates.
“With continuing speculation that the RBA will cut interest rates again before the year’s end, locking money away in a market leading term deposit now can help reduce the impact such a cut will have on cash savings,” Hewson said in July.
Australian Unity warned investors late last month that falling interest rates were making a term deposit strategy increasingly unsound.
Falling interest rates and inflation together will reduce the value of capital and income, which is exactly what investors seeking a safe haven are trying to avoid, the company said.
But falling interest rates are simply making investors plough money faster in term deposits.
“We see a lot more activity in the lead-up to announcements by the RBA,” Hewson says.
Term deposits become a much broader and more important consideration for investors if there has been a subsequent reduction in the cash rate, he adds.
Two years ago, Dorrian wrote in Money Management that comparably poor performance and illiquidity issues should cause advisers to rethink using term deposits.
Illiquidity costs of term deposits are not well understood, with half of advisers surveyed categorising term deposits as cash, and the remainder putting them in the fixed income basket, Dorrian wrote.
Investors also lose out on opportunities, with the cash rate rising and falling, and possibly locking investors into a disadvantageous interest rate.
Dorrian has lost none of the sense of urgency of the situation.
In 2007 to 2008, when banks were looking for domestic funding, Westpac offered five-year term deposits at 8 per cent interest, and it was swamped by investors.
Now those five years are ending, and investors will be faced with an urgent question of what they should do with their money.
“That level of income from term deposits is not achievable now,” Dorrian says.
Investors have no control over when they have to make a decision of what do with their money, he says.
Hewson warns that investors wanting to lock money away for five years need to make sure that it suits their liquidity profile.
The right time frame has a lot to do with investor requirements, which is different for every investor, he says.
Breaking a five-year term deposit before the term ends can come with prohibitive penalties.
Depending on the relationship an investor has with his/her bank, they could lose the interest on the deposit completely, while some banks were suggesting at one point that investors could lose part of the capital in the term deposit.
The Government guarantee is also likely to disappear at some point in the future, reducing the attractiveness of term deposits. It has already been reduced in scope.
The increasing use of term deposits could also be creating unacceptably high concentration risk, Dorrian says.
Most investors take out a term deposit with the institution in which they have their primary banking relationship, putting most of their investment risk with one single issuer.
In a portfolio, that would be flagged as very high concentration risk and investors would be urged to diversify their holdings.
Investors aren’t considering that issue either, according to Dorrian.
For now, term deposit providers and their opponents will battle it out for the hearts and minds of investors.
Hewson claims there will be a benign level of term deposit activity in the future as investors remain cautious about investing, but at the same time Bryant warns investors that diversification is always the best approach no matter what the situation is.
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