Have term deposits lost their appeal?
As we enter the post-global financial crisis era, investor confidence is returning and interest rates are staying at record lows. But has the lustre worn off term deposits as growth assets become more attractive – or does it have to be an either/or proposition? Malavika Santhebennur investigates.
As the global financial crisis (GFC) sent tremors through the market in 2008, term deposits became much more than just a way to balance an investor’s portfolio.
By the time year 2012 rolled around, the so-called wall of cash seemed impenetrable and term deposits were deemed one of the most popular products out there, as investors sought refuge from the ever volatile equity markets.
There were about 10 million term deposit accounts in Australia in 2012 worth $725 billion, according to comparison website RateCity.
According to Investment Trends research, financial planners put 8 per cent of new client money into term deposits in October 2010.
This more than doubled to 17 per cent in November 2011 when there was a lot of volatility and investment fear. This peaked in late 2012, with financial planners putting a fifth of new client money into term deposits.
But now, having moved into the post-GFC era, markets are stabilising and investor confidence is returning. Interest rates are at record lows, with the Reserve Bank of Australia deciding to keep the cash rate at 2.5 per cent at its first meeting of the year.
This has been mirrored in declining enthusiasm for term deposits. There has been a gradual shift towards investing in growth assets as investors are more readily inclined to put their feet back in the water.
In August 2013, financial planners were putting only 11 per cent of new client money into term deposits, Investment Trends August 2013 Adviser Product and Marketing Needs report showed.
“Because investors were more bullish and they had greater market return expectations, advisers just started putting more money into growth assets,” Investment Trends senior analyst Recep Peker said.
“What’s happened is because confidence came back in 2013 and investors were generally less concerned about the situation in the share markets, planners are putting more money into growth assets as they reduce term deposits.”
Peker said Australian investors have become a lot more yield-oriented as interest rates remain low. Many investors are looking to get this extra yield or income through direct shares at the moment, and they prefer using cash and other fixed income investments.
As national property prices increase, term deposits have fallen by 0.6 per cent in the year to December 2013, according to RateCity figures.
Some are moving, some not
Brisbane-based Tupicoffs financial planner James Kenny said he has seen a number of clients who were in defensive investments with only 25 per cent exposure to growth assets suddenly becoming more comfortable with taking a slightly more aggressive approach.
The low cash rate has led them to increase their exposure to growth assets to 40 per cent in a portfolio to try and get a potentially higher return.
Unified Financial Services director and principal financial adviser Michelle Tate-Lovery conceded there has been a reduction in term deposit rates.
Among the big four banks, ANZ and Commonwealth Bank are offering a 3.3 per cent return rate for a one-year term deposit on $50,000, while Westpac is offering 3.35 percent and National Australia Bank is offering 3.4 per cent. ING Direct’s term deposit rate is at 3.9 per cent.
At its peak, Commonwealth Bank was offering a 5.3 per cent return rate in January 2012, and Westpac was offering 5 per cent.
Despite the drop-off in rates, Tate-Lovery is generally not seeing a change in the company’s client risk profiles.
She added that her clients are quite conservative so they are not rushing to get into or out of growth assets. They still have a defensive component in their asset allocation.
“The more exposure to cash and fixed interest a client has the lower the return. But are clients actually moving out of cash to be more invested in growth assets? Not in my experience.
“I suppose it depends upon how you structure a portfolio, but there’s always a growth element and a defensive element to portfolios,” she said.
“So ultimately the allocation to growth assets isn’t automatically going to change for a client just because stock markets have improved in value.”
Tate-Lovery said through an education process, clients understand that they need to have a defensive component in their investment.
Because clients are already getting a higher return in growth areas such as the stock market – and their overall portfolio is still delivering according to their expectations – they are not chasing the higher returns.
“We don’t want clients chopping and changing all the time where they buy stocks when markets are more buoyant. That’s not necessarily the way our client base works. It’s steady as she goes,” she said.
“We want to make sure the type of portfolio, the asset allocation, is going to deliver to them long term and deliver to their goals, so that they don’t have money running out.
“If clients don’t need to risk, then they shouldn’t be concerned about chasing those higher returns.”
Quantum Financial director Claire Mackay shares a similar view to Tate-Lovery, saying that when she talks to clients about the defensive component of their investment, she is putting term deposits back on the table despite the relatively low rates.
“If we look at interest rates, they are low but the expectation is that they will go up and therefore bonds will go down,” she said.
“So if we’re looking at how to allocate the defensive component of a client’s portfolio, would you put your money in bonds at the moment? Most people don’t want to use bonds at the moment because they fear that if interest rates go up, the bond values will come down.”
There are other clients who prefer saver accounts with institutions such as UBank or NAB which have higher rates on-call than term deposits, Mackay added.
Fixed rates continue to make up a large portion of a household deposit, accounting for over 50 per cent of the household market, ING Direct head of product Michael Christofides said.
Most of ING Direct’s term deposits come through the adviser channel, with the bank’s savings portfolio adding $2.5 billion over the last 12 months.
Term deposit rollover rates have remained consistent despite investor sentiment improving, Christofides said. It is somewhere between 70 and 75 per cent for consumers, and a little lower in the adviser market at between 60 and 65 per cent.
Volatility still important
“I think a part of that is while sentiment has improved there is still quite a bit of volatility in the market. People are looking at different asset classes but at the same time, while markets have improved, there’s also been quite a bit of volatility,” he said.
The key thing investors look for when it comes to cash and other fixed income allocations is capital preservation, according to Peker. But investors tend to go for higher yielding term deposits when it comes to picking individual term deposits.
Half of financial planners say term deposits offer safety from capital loss. Another reason planners value them is highest interest rates – but this is a long way behind at 27 per cent.
“You can see that capital preservation is actually more important and it plays a greater role,” Peker said.
Most investors tend to invest in term deposits directly, while financial planners place less than half of term deposit money through platforms.
“I think one of the main reasons is because of the limited range of term deposits that are available on most platforms,” Peker said.
“Also, if you’re on BT Wrap, which is the most widely used wrap by financial planners, you can only access Westpac term deposits.
“Whereas, if the client was saying they want a term deposit from UBank, then the planner would have to go elsewhere. That’s why fewer than half of the term deposit flows go through platforms.”
Mackay said her clients are predominantly self-managed super funds, which allows them flexibility. They do not have cash sitting on a platform.
“Putting term deposits on a platform, you’re not going to get a great rate, you’re going to get slugged on fees,” she said.
But Peker said most platforms had changed so that clients do not have to pay fees in this area anymore.
Macquarie Banking and Financial Services Group head of cash product Peter Forrest said investors place term deposits both through and outside of platforms, adding that wrap platforms ensure all the administration gets done in the one place.
Another popular way of investing in cash is through cash management accounts (CMA), which continue to be popular at Macquarie.
According to Forrest, CMAs are not influenced by economic conditions but by how many customers are looking to manage their financial affairs and cash in and out of their investments.
According to Macquarie’s half yearly report, it had a CMA balance of $18.8 billion, up 9 per cent on the first half of 2013 and up 7 per cent on the second half of 2013.
“We’ve continued to grow over the last two years, which is primarily being driven in our cash management account,” Forrest said.
“And that’s really from investors opening cash management accounts who have adviser accounts and stock brokers. We’ve continued to see growth of new accounts.”
With low interest rates and low returns on term deposits, are equity income funds an attractive option?
Most financial planners are reluctant to answer this question because there is no black and white answer. It depends on the purpose of the portfolio.
As Mackay points out, an income fund is a managed investment scheme that is either listed or unlisted, mostly unlisted. With cash and term deposits, clients can access the money any time – at a penalty.
“The concern with the funds is how long you are planning to be in there. I’m not going to say that one’s better than the other. It’s more about what the purpose is in the portfolio,” Mackay said.
“What’s our plan B if everything does go south? It’s meant to be defensive, so how is it going to defend the portfolio if something does go wrong?”
Mackay points out that the returns may be higher in another type of investment – but that is not of much use if clients cannot access it when needed.
Christofides said younger clients who have a longer-term outlook in their retirement profiles are generally prepared to ride the ups and downs of the share market, while older clients are suited more to secure cash and income-based funds.
But he is hesitant to say which one is better valued as it comes down to individual client needs and portfolios.
Tate-Lovery believes the two are completely different investments, with different levels of risk associated with each one.
She feels it is important to constantly educate clients about their decision to have some weighting in the share market, some in growth investment, and some in defensive or fixed interest investment.
“We don’t want a situation where clients are feeling exuberant because their neighbour is talking about the best returns they’ve had in their portfolio, and our clients are looking at their portfolio and saying ‘but I only had a 15 per cent return, my neighbour got a 20 per cent return’,” she said.
“Our clients are not chasing those higher returns because they understand that there is a risk component of it.”
Buying bank stocks that are paying a 5 per cent franked income could be appealing to a low income person or retiree, as it could be a 7-8 per cent yield play for a client compared to 3-4 per cent term deposit rate.
But there is a growth risk element to buying those stocks because the price value can drop.
Conclusion
If market performance continues to be positive and investors remain bullish, more clients are likely to go into growth assets, Peker believes.
But he said there is still a growing appetite for fixed income investments among retirees or those heading to retirement.
“If you think about it, each year there are 100,000 more Australians who are aged more than 55, so as they get closer to retirement they will have to de-risk eventually.”
Most predict the RBA will keep interest rates on hold for a period of time. Kenny believes retirees will feel the heat of low cash rates most when it comes to term deposits as they fail to get a return that is going to supplement their drawdown rate.
Mackay believes retirees need to be able to fund their lifestyle and will always need cash available. She says retirees should have sufficient reserves for a year’s worth of living expenses if something should happen in the market.
Christofides believes one cannot look at the term deposit market in isolation. The volatility of the other markets also has to be taken into account, especially the equity markets.
“We know from looking at self-managed superannuation fund trends that a large portion of money is held in cash,” he said.
“There has been a slow uptick back towards the equity markets – but it hasn’t been a rush of money back to the equity markets.”
Christofides said a lot depends on the value clients and advisers place on the other markets, and whether they decide it is right to get back into markets or whether to play it safe with deposits.
“We’ve started to see a little bit of the money coming out of term deposits and cash investments and start trickling into the direct shares facility. People are starting to put their toes back into the water.”
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