Banks Tighten Term Deposit Rules

Australian Banks with effect from 1st January 2015 will require investors to provide 30 days notice if they wish to break the term of an existing term deposit.

Until now, banks have offered various penalties for the ability to break term deposits, but from next year there will be uniformity in requiring clients to provide notice to break term.

The advantage of this is that it will allow the banks to better manage their funding requirements.

The chief executive of Curve Securities, Andrew Murray, said banks were making the changes in response to new rules designed to make sure banks have enough liquid assets to survive 30 days of financial turmoil.


Under the so-called liquidity coverage ratio (LCR), which is commencing in January, banks must hold enough liquid assets to cover their lending outflows for a month of turmoil.


"They need to prove they've got enough funds to withstand a thirty-day run," he said.


Mr Murray said the change could be significant for retail investors who needed the flexibility to withdraw term deposit funds at short notice.

"In the past they've been able to break their deposits reasonably easily, the banks have been pretty flexible. But now they can't," said Mr Murray, who manages almost $4 billion in deposit products on behalf  councils, credit unions and universities.


It is understood the change will apply to all term deposits, including those issued before the rules came into effect.


The LCR, which the Australian Prudential Regulation Authority will implement from January, will mean banks incur extra costs when managing money that could be withdrawn at short notice.


Term deposits will not be the only products affected. Mr Murray said this may also make online saver accounts less attractive to banks, pushing down the bonus levels of interest that are often paid.


 This is an important change in banking procedures and one that investors should take notice of.

New levy on bank deposits - not on banks

Expect depositors to take the hit!

Media outlets reported on Thursday that the Federal Government was planning to introduce a deposit insurance levy on Australian Banks.  Details of the proposed change have just been released.

The levy is to be implemented by the way of fixed fee of 0.05% on deposits up to $250,000.  There are a number of possible reactions by the banks to such a levy. Banks will either (i) absorb the fee and deliver a lower profit to shareholders, (ii) source additional revenue through fees and higher mortgage rates, or (iii) reduce the deposit rates paid to investors.

Given the oligopolistic nature of the Australian banking industry, we think outcome (iii) is most likely.  Indeed, Australian Bankers Association head Steven Munchenberg said that he expects that the banks will pass the levy on to customers in terms of lower interest rates on their deposits.  Combined with an anticipated cut in official interest rates from 2.75% to 2.50% at the RBA’s meeting next Tuesday, Australian savers face the prospect of a one-two hit to their income stream in quick succession, after already suffering significant reductions in income streams following a series of successive interest rates cuts since October 2011.  The question investors need to answer becomes what should they do in the face of these changes.

Sacrifices in income levels and lifestyle are embedded in the lower returns from bank deposits, making alternative sources for yield more compelling. Take for example, the current Australian equity market yield of around 4.3% net. After including the full benefit of franking credits, the gross yield of the Australian share market becomes 5.7% which is more than double the RBA cash rate.

Finally - it must be remembered that this is not yet law, and it's outcome depends on the timing of the election, and who wins.

This material has been provided for general information purposes and must not be construed as investment advice. This material has been prepared without taking into account the investment objectives, financial situation or particular needs of any particular person. Investors should consider obtaining professional investment advice tailored to their specific circumstances prior to making any investment decisions and should read the relevant Product Disclosure Statement.

Funds in Australian bank term deposits - record highs $546bn

We have spoken previously about current cash levels in Australia in term deposits, as a supporting factor share prices going forward.  Should investor confidence improve, and investors look to invest some of this, it would be positive for share prices.

The chart below highlights the weight of money still sitting in the safety of cash at a time where cash returns are likely to be further depressed by RBA interest rate cuts.

Funds in Australian bank term deposits are at record highs of $546bn.






RBA keeps rates on hold in Feb - next move likely to be lower

As expected the Board of the Reserve Bank decided to leave the cash rate unchanged at 3.0%.

However there was considerable encouragement in the statement for our near
term view that they will decide to cut rates by 0.25% at the next meeting
on March 5.

The most important justification for that expectation is around the
sentence in the final paragraph: "The inflation outlook as assessed at
present would afford scope to ease policy further should that be necessary
to support demand." Our experience is that use of that word "scope" in a
forward sense indicates a decent chance that the Bank will move at the next

The discussion around the domestic economy was largely similar to the
discussion following the December Board meeting. That is, two extra months
of low rates have not provided the Board with much encouragement that
things are turning. For example, investment outside mining is still
described as "remains relatively subdued". The labour market is still
described as "softening somewhat and unemployment edging higher". And
consumer spending is described as "moderate growth".

On the other hand there is a modest uplift in the assessment of the housing
sector with house prices being described as "moved higher" compared to the
December assessment of "moving a little higher". The strength of car sales
is recognised for the first time: "the demand for some categories of
consumer durables has picked up". And the mild reduction in risk aversion
by savers is noted: "savers are starting to shift portfolios towards assets
offering higher expected returns".

Some new concerns emerge in the statement. Firstly, a sign that the Board
is concerned about the outlook for employment growth: "businesses are
likely to be focussing on lifting efficiency". And recognition of the weak
credit growth in both households and firms: "some households and firms
continue to seek lower debt levels". Despite a modest fall in the AUD and a
30% jump in the iron ore price since the last Board meeting, the Board
continues to note the high exchange rate in a context of the observed
decline in export prices.

The main motivation for markets beginning to price out further rate cuts is
around developments in the world economy. In previous statements, the
Governor had consistently described risks to the global economy as to the
down side because of Europe. He now qualifies that by talking about these
risks having "abated, for the moment at least". However, he notes that the
build-up in public and private debt still affords vulnerability to
financial markets.

The wording around China is a little more upbeat with growth being
described as "fairly robust pace", while he is more constructive around
prospects for the rest of Asia due to the improved overall global
environment. Surprisingly no attention is given to the recent upswing in
iron ore prices with export prices still being described as having

We expected that recent optimism around the world economy would not be
sufficient to change the Bank's clear bias to further cut rates. This
expectation has been confirmed more strongly in this statement than we had
expected. In qualifying the recent improvement in financial conditions it
is clear that the Board does not believe that the global economy is on a
sustained upswing.

Commentary around the domestic economy highlights new concerns around the
outlook for employment growth and credit while the description of the
housing market is hardly exuberant. From our reckoning we are also seeing
for the first time guidance that the Bank expects growth to be "a little
below trend over the coming year" – that is consistent with the current
forecast of 2.25 to 3.25% in the November Statement on Monetary Policy.
However it is interesting that this "below trend" concept is raised in this
particular statement given that has not been the practise in the past.

In May last year we forecast that the cash rate which at the time was 3.75%
would bottom out at 2.75% some time near the end of 2012 or the beginning
of 2013. Today's statement has given us considerable encouragement that
this last leg in the cycle is likely in the near term and we maintain our
call that another cut can be expected in March.

Bill Evans
Chief Economist
Westpac Institutional Bank


This material has been provided for general information purposes and must not be construed as investment advice. This material has been prepared without taking into account the investment objectives, financial situation or particular needs of any particular person. Investors should consider obtaining professional investment advice tailored to their specific circumstances prior to making any investment decisions and should read the relevant Product Disclosure Statement.

The end of the “do nothing” investment strategy

I believe to write accurate investment strategy you have to forecast where capital will flow. I know that sounds an obvious statement, but too often in the professional investment world investors/analysts/strategists over complicate and over analyse very simple themes.

For the last nine months we have forecast that falling local and global cash rates would force savers out of cash and lead to sustainable dividend yields being bid down in the equity market. We believed all those who relied on investment income to live would be forced up the risk curve.

Australia has been late to this equity yield compression party because we previously offered acceptable returns in cash to savers who wanted to preserve capital. Yet, with the RBA crushing cash rates to 3.00% and banks lowering their margin on term deposits from a peak of 2.00% over swap to 1.20% over swap, post tax returns on unfranked term deposits are collapsing bringing an end to the “do nothing” investment strategy.

I believe you can sense a change in the RBA’s rhetoric where they are starting to follow the FED. The RBAhave basically told investors that they are going to have to acceptable higher risk to generate the returns they require. Whether that involves buying a rental property, equity dividend yield or corporate debt, I believe you can see the RBA is moving to force savers out of cash and into productive assets. As those asset prices rise it should in turn generate a rise in consumer and business confidence.

30% of Australian super funds are now self-managed. Data suggests around 30% of SMSF assets are currently held in cash or cash equivalents. 90% of all Australian bank term deposits are of 1yr year duration or less. Our strategic view is that wall of increasingly low return cash is going to move to higher income stream assets over the years ahead.

On that basis our research department, led by retail investment strategist Peter Quinton, ran a model comparing the after-tax returns from bank term deposit rates vs. other higher risk bank products. This is a really good piece of work.

In the table below we are comparing the return if you were to invest $100,000 in a: 12-month term deposit, a subordinated debt issue (sub—debt), a hybrid issue (hybrid), and the grossed-up fully franked dividend yield from the bank equity (shares). The table below compares the return based on 7/12/2012 the top marginal tax rate for individuals of 46.5%, the tax rate paid by Superannuation Funds (15%) and the tax rate paid by Superannuation Funds in pension mode (0%).

In this example we have assumed the interest on the term deposit will be paid at maturity and the rates are from Monday 26th of November. The equity yield is the estimated yield for fy13 based on Bell Potter research notes. The sub-debt referred to is subordinated debt; ANZHA, CBAHA, NABHA, WBCHA. The hybrids referred to are the mandatory convertible preference shares; ANZPC, CBAPC and WBCPC.

What I want to focus you on today is the differentiated after-tax returns between term deposits and bank equity dividend yield at the two superannuation tax rates. While the sub-debt and hybrid analysis is interesting, I want to focus on the equity vs. TD returns inside a super fund structure.

For example, a NAB TD inside a 15% tax rate paying super fund returns 3.74% after tax vs. NAB equity dividend yield @9.52% after tax. Further, a NAB TD inside a super fund in pension mode paying 0% tax returns 4.40% after tax while NAB equity dividend yield returns 11.2% after tax.

Now, looking at the lowest dividend yield bank, CBA. A CBA TD inside a 15% tax rate paying super fund returns 3.40% after tax vs. CBA equity dividend yield @7.65% after tax. Further, a CBA TD inside a super fund in pension mode paying 0% tax returns 4.00% after tax vs. CBA equity dividend yield @9.00% after tax.

Six months ago we recommend investors get out of bank term deposits and into bank equity dividend yield. Of course at the time that call was criticised by the financial press who said we weren’t comparing apples with apples because there always should be an equity risk premium paid to investors in equity to compensate for volatility and risk. We completely agree, but as after tax returns get crushed in unfranked cash products we
believe the equity risk premium in terms of after-tax return premium offered by bank equity dividend yield is compelling, in fact, the equity risk premium is too high and likely to be bid down in the years ahead.

In the average 15% tax paying super fund the after tax return in pure income terms from NAB shares is 2.54x higher than currently offered by NAB TDs (9.52% vs. 3.74%). For those super funds in pension mode the after tax return in pure income terms from NAB shares is also 2.54x higher than currently offered by NAB TD’s (11.2% vs. 4.40%). In our lowest risk bank, CBA the after tax return in pure income terms inside a 15% tax paying super fund is 2.25x higher in CBA shares over CBA TD’s (7.65% vs. 3.40%). In a super fund in pension mode the after tax return in pure income terms is also 2.25x higher in CBA shares of CBA TD’s (9.00% vs. 4.00%). In other words, you are being paid a huge after tax equity risk premium (in income terms) to move from TD’s to bank equity.

It’s also worth remembering that this analysis is based off current TD rates. In the macro strategy we believe in we see the RBA taking the cash rate to 2.50% and banks offering around 120bp over swap for 1yr term deposits. That equates to 1yr TD rates of 3.70% at some stage next year. When TD’s have a “3 handle” the switch to equity dividend yield will accelerate.

The analysis above also reminds you of the after tax return power of franking credits inside a superfund structure, particularly one in pension mode. You can see why I see a wall of money moving into high, sustainable fully franked equity dividend streams ahead as Australian superannuants move from capital protection mode to retirement income protection mode.

Unfranked cash is no longer king; fully franked sustainable dividend yields are now king.

We continue to have all 4 major banks, Suncorp and Telstra in our high conviction buy list on this theme and remind you of our share price targets on those stocks based of dividend yields being bid down to 6.00% in fy14. I am actually starting to think those yield based targets will prove conservative if TD’s have a 3 handle.

If this note unintentionally ends up in the hands of the media or competitor investment banks I remind you that you do NOT have my permission to quote me or in any way reproduce or retransmit, in part or in whole, the content contained in this note. We will enforce via legal action our Copyright© claim if our Copyright© is breached in any way.

Charlie Aitken - Bell Potter (reproduced with Charlie's permission)

This material has been provided for general information purposes and must not be construed as investment advice. This material has been prepared without taking into account the investment objectives, financial situation or particular needs of any particular person. Investors should consider obtaining professional investment advice tailored to their specific circumstances prior to making any investment decisions and should read the relevant Product Disclosure Statement.



RBA has more to do - how low will the cash rate go?

Interest rates dice

Key Points

  • The reserve Bank of Australia (RBA) will have to cut interest rates further to boost the non-mining sectors of the economy as the mining boom fades at a time when the Australian dollar remains strong and fiscal cutbacks are intensifying.
  • After the global financial crisis (GFC) caution has likely resulted in a reduction in the neutral level for bank lending rates, as they are only now starting to become stimulatory.
  • Our assessment remains that standard variable mortgage rates will need to fall to around 6%, which implies that the official cash rate will need to fall to 2.5%. We expect this to occur over the next six months, with the RBA cutting again next month by another 0.25%.
  • Bank deposit rates will fall further, but the Australian share market is likely to be beneficiaries as lower interest rates eventually boost housing activity and retailing.


The Australian economic outlook has deteriorated. Recognising this, the Reserve Bank of Australia (RBA) has cut interest rates. Our assessment remains that the RBA has more work to do. But how low will rates go? What does it mean for investors? The growth outlook while economic growth in Australia has been reasonable of late, approximately 3.7% over the year to the June quarter, and well above growth in comparable countries, our assessment is that storm clouds are brewing and that growth will slow to around 2.5% in the year ahead, which is well below trend growth of around 3%-3.25%. The basic issue is that the mining boom is losing momentum at a time when the non-mining part of the economy is weak and fiscal austerity is intensifying:

  • Mining investment looks like it will peak next year. For the first time in years the June quarter survey of mining investment intentions did not show an upgrade in plans for the current financial year and projects under consideration have peaked. Falling mining sector profits suggests mining projects remain at risk. Investment outside the mining sector remains weak. This all points to a sharp slowing in business investment in 2013-2014.


  • At the same time, a sharp fall in Australia’s terms of trade is leading to a loss of national income which will also slow spending and growth. Stronger mining exports will provide a boost to growth but this may not become evident until around 2014-2015.
  • This is all occurring at a time when non-mining indicators for the economy remain soft. Consumer and business confidence are sub-par, despite being almost a year into an interest rate cutting cycle.
  • Retail sales remain subdued, with government handouts providing a brief boost in May and June, only to see softness return again. Annual retail sales growth is stuck in a range around 3%. With confidence remaining sub-par, job insecurity running high and interest rates still too high, its hard to see a strong pick up in the near term. Ongoing consumer caution in terms of attitudes towards debt and spending is highlighted by the next chart showing a much higher proportion Australians compared to the pre-GFC period continuing to nominate paying down debt as the wisest place for savings.

A higher proportion of Australians are focused on paying down debt

  • While, on average, housing related indicators have probably bottomed, taken separately they present a very mixed picture.  House prices are up over the past few months. Housing finance, housing credit and building approvals look like they have bottomed, but remain soft. In addition, new home sales are still falling. The fact that there has only been such a tentative response to lower mortgage rates indicates that mortgage rates have not fallen enough.
  • The jobs market remains soft with weak job vacancies pointing to soft employment and rising unemployment ahead. Whereas anecdotal news of job layoffs was previously limited to the non-mining sectors of the economy, it has now spread to the mining sector. This is likely fueling ongoing household caution, acting to constrain retail sales and housing demand.

The bottom line is that with the mining boom likely fading over the year ahead, the non-mining part of the economy (e.g. retailers, tourism, manufacturing, and housing and
non-mining construction) needs to pick up to fill the breach. The good news is that the RBA appears to recognise this. The bad news is that its task is being made challenging
by two factors:

  • First, the continuing strength in the Australian dollar, presumably on the back of safe haven buying, and moving out of the US dollar and euro in the face of QE3. In addition, the Australian dollar has a high correlation to the US share market as part of a ‘risk on/risk off’ trade, which has meant that it has not provided the shock absorber it usually does to falling commodity prices.
  • Second, having seen the budget handouts around mid-year, fiscal tightening will now kick in at the federal level and may even intensify if the government seeks to retain its projected surplus for the current financial year. At the same time, various states are announcing budget cutbacks, including job cuts.

In order to offset these forces and ensure that non-mining demand strengthens sufficiently, interest rates will have to fall further.

The cash rate is low but lending rates are not

While the RBA has cut the offi cial cash rate to within 0.25% of its GFC low, because of bank funding issues lending rates are still well above their 2009 lows.

Basically banks have been seeking to reduce their reliance on non-deposit funding which has proved unreliable since the GFC. To do this they have had to offer higher deposit rates relative to the cash rate than would normally be the case. This has resulted in higher lending rates relative to the cash rate than was the case pre-GFC. Banks have done well to raise the proportion of their funding they get from deposits to 53% from around 40% pre-GFC, but they still lag behind banks other major countries and tougher capital requirements mean they are under pressure to do more.

The standard variable mortgage rate is below its long term average of 7.25%. It is currently around 6.6%, assuming banks pass on around 0.2% of the RBA’s latest 0.25% rate cut. However, normally rates need to fall well below their long-term average to be confident stronger growth can be delivered. In an environment of household and business caution post-GFC, the neutral rate has likely fallen, probably to around 6.75%, which is shown as
the ‘new neutral’ level in the next chart. This would suggest that current mortgage rate levels are only just starting to become stimulatory.

In the last two easing cycles the mortgage rate had to fall to around 6.05% in 2002 and to 5.8% in 2009. Given the fall in the likely neutral level for mortgage rates and the current headwinds coming in the form of the strong A$ and fiscal tightening, mortgage rates will at least need to fall to these lows. Given the ongoing issues with bank funding, to achieve a circa 6% mortgage rate the cash rate will need to fall to around 2.5%.

Interbank lending spreads have collapsed in Europe

Our assessment is that the RBA is coming around to this view. As such we expect another 0.25% cash rate cut next month on Melbourne Cup day, followed by a cut to 2.5% in the March quarter next year.

Based on the assumption that the RBA cuts interest rates further, the global economy stabilizes and growth in China stabilizes around 7.5% next year then Australian economic
growth should pick up again by the end of 2013.

Implications for investors
There are a number of implications for investors.

  • Interest rates need to fall a lot further. This means that term deposit rates are likely to fall further in the years ahead, even though the size of the decline will lag that of the official cash rate given bank funding reasons. As a result, the attractiveness of bank deposits for investors will continue to deteriorate.

Bank term deposit rates likely to deep falling


  • While record low bond yields mean bonds are poor value for long term investors, yields will likely remain lower as the RBA cuts interest rates. However, if foreign investors start to develop concerns surrounding Australia, international bonds will do better than Australian bonds.
  • Australian shares should benefit from interest rate cuts and cheaper valuations. We continue to see the Australian share market being higher by year end. Key sectors likely to benefit from lower rates are retailers, building materials and home builders.
  • Declining interest rates in Australia will take pressure off the Australian dollar. However, a fall in value is likely to be constrained by quantitative easing in the US and central bank buying. Overall we see the Australian dollar stuck in a range around US$ 0.95 to US$ 1.10. The best has likely been seen for the Australian dollar.


This material has been provided for general information purposes and must not be construed as investment advice. This material has been prepared without taking into account the investment objectives, financial situation or particular needs of any particular person. Investors should consider obtaining professional investment advice tailored to their specific circumstances prior to making any investment decisions and should read the relevant Product Disclosure Statement.


Why don't mortgage rates move in line with RBA rate moves

With the constant symphony of politicians from all parties clamouring over each other to bash up the banks and accuse the Australian banking industry of profiteering from mortgage holders since the GFC, we examine the truth behind why the interest rates on home loans have risen more than the official Reserve Bank cash rate.

First some revision, where do banks source money to enable them to lend out to homeowners?  Banks can either attract deposits by offering term deposits and cash accounts or they can "buy" money from the wholesale market, largely from overseas.

The graph below shows the increase in the cost to acquire these sources of funding since the start of the GFC, courtesy of Commonwealth Bank's analyst pack at their recent results presentation.

The chart highlights that Australian banks have paid an additional 1.65% to obtain funds from the wholesale market and have had to pay cash account and term deposit holders 1.86% over what they were paying before 2007 to attract funds.  Those who watch term deposit rates would know this as term deposits are currently more than the RBA official cash rate of 3.5%, whereas prior to GFC banks paid around 1.5% below the cash rate for deposits (source RBA Bulletin March 2010)

Despite having to pay on average 1.78% more to acquire funds to lend out, CBA's increase to the standard variable home loan rate has been less than 1.5% which means that the bank has absorbed some of the pain of the increase cost of funding.

The bank bashers will not accept this and point to their record profits.  The banks higher profitability has come through acquiring several of the second tier lenders such as BankWest (CBA) and St George & RAMS (Westpac) so one would hope their profits are higher as their businesses are now much larger.

We readily accept that the cost to build a house has increased due to the increased cost of raw materials such as steel and timber, and yet when the cost of "raw materials" for banks increase we accuse them of gouging.

Australia should be proud of our healthy banking system and pay no attention to the ill informed politicians who are bank bashing to distract voters from their own inadequacies.




Investing for Income Yield in Difficult Times


Key points

  • With yields on shares up and yields on bonds down, shares likely offer a decent return premium for long-term investors notwithstanding ongoing short-term uncertainty.
  • However, for those who can’t take a long-term approach, outcome-based approaches or focussing on investment yield are worth considering.
  • While term deposit yields are falling, attractive alternative sources of yield can be found in Australian shares, corporate debt, non-residential property and infrastructure.


The investment environment remains tough. On a long-term basis, shares and other related growth assets look attractive after several years of poor performance. Against this, Europe and the US are continuing to suffer aftershocks from the global financial crisis, resulting in periodic falls in investment markets as investors run for safety only to be reversed again as government policy-makers swing into action. Meanwhile popular safe havens such as government bonds and bank term deposits are becoming less attractive as yields fall.

So what should investors do? There are essentially three options: sit tight and ride it out; consider outcome-based strategies; or focus on yield-based investments.

Sit tight

History shows that over long periods of time, shares provide higher returns than cash or bonds. This can be seen in the following chart, which shows that since 1900 Australian shares have returned nearly 12% per annum (pa) compared to 6% for bonds and 4.8% for cash.

In a longer-term context what we are going through right now is not particularly unusual. From late 1969 through much of the 1970s, shares churned roughly sideways (albeit with a 60% slump in share prices along the way). Also, from a high in 1987, accumulated share market returns didn’t reach a new high until 1993. But after each of these episodes, shares resumed generating solid returns.

It is also worth noting that over the last thirty years or so government bonds have been in a massive bull market as ten-year bond yields have fallen from around 15% in the early 1980s to record lows in the US now and near record lows in Australia. The Australian ten-year bond yield is now 3.14%, a level which was last seen in May 1941 at the height of World War II. The record low for ten-year bond yields was in September 1897 at 2.9%.

This massive decline in yields from the early 1980s was driven by the adjustment from high inflation to low inflation and more recently by worries about global deflation following the global financial crisis. It has generated huge capital growth and hence returns for bond investors. However, with bond yields so low, the days of high returns from government bonds are behind us. Sure, bond yields could fall below 1% if Japanese-style deflation sets in. But it is hard to see the US Federal Reserve Chairman Bernanke or Reserve Bank of Australia (RBA) Governor Stevens allowing this. In the meantime an investor who buys a ten-year bond today and holds it to maturity will get the spectacular return of 1.74% pa in the case of US bonds or 3.14% pa from Australian bonds.

The dividend yield on Australian shares today is around 5% (or 6.5% if franking credits are allowed for). Only modest capital growth of 5% pa will generate a total return of 10%, which is well above the prospective return on bonds.

So while the secular bear market in shares may have further to go, reflecting public and private debt deleveraging in key advanced countries, extreme monetary policy settings and less business friendly governments, at least a lot is already factored in and given current starting point valuations (higher yields on shares and low yields on bonds) shares should provide a decent return premium over bonds. So on this basis it may be best to stay put with previously agreed strategies focussed on the long term.

However, that may be fine for someone who can take a long-term investment horizon, but it may not be so good for those near to retirement or in retirement (like my Mum) and with modest investment balances. Of course it also ignores the opportunities for taking advantage of extreme market moves along the way. So it is worth considering alternatives.

Outcome-based investing

Outcome-based investing involves investing in funds that target a particular outcome in terms of return (say inflation plus 5% pa) or income. The key elements of a multi-asset fund managed along these lines would be a focus on overall risk, highly flexible asset allocation capabilities (often referred to as dynamic asset allocation) and wide sources of market returns. This is in contrast with the traditional approach which involves constructing a benchmark mix based on simplistic growth/defensive categorisations and assuming it will deliver to client risk and return expectations.

Yield-based investing

Another approach, which can be seen as a subset of outcome- based investing, is to focus on assets that provide a decent investment yield. This is attractive because assets with a decent and sustainable yield provide a greater certainty of return in an environment of high market volatility and constrained capital growth. However, many of the traditional options here are becoming less attractive.

The traditional safe asset – government bonds – has seen yields collapse to record or near record lows. Australian ten-year bond yields have fallen to 3.14% and five-year bond yields (indicative of the yield on an Australian government bond portfolio) are just 2.5%. The average yield on global government bonds is around 1.5%, which is all the more amazing given that Japan and the US, which have the highest weight in global sovereign bond indices, have worse public debt levels than Europe.

Bank term deposit rates are now falling with the RBA cutting official interest rates. The collapse in bond yields points to further falls ahead, reflecting a combination of increasing global uncertainty, a moderation in growth in China taking the edge off the mining boom, struggling conditions in non-mining sectors and benign inflation. We expect the cash rate to fall to around 3%, which will likely see bank term deposit rates fall to around 4%.

Housing used to be seen as an attractive source of investment yield, but after the house price boom of the past twenty years this is no longer the case, with the rental yield on houses around 3.6% and that on apartments around 4.7%. After costs net yields are around 1% for houses and 2.2% for apartments and after a long bull market, Australian house prices are vulnerable to an extended period of poor capital growth.

However, there are several alternatives to term deposits, government bonds and residential property in terms of assets that provide decent income. See the next chart.

The grossed up dividend yield on Australian shares at around 6.5% is now above term deposit rates meaning that shares are actually providing a higher income flow than bank deposits. Of course, shares come with the risk of capital loss. One way to minimise this is to focus on stocks that provide sustainable above average dividend yields as the higher yield provides greater certainty of return during tough times. Excluding resources, the grossed up dividend yield on Australian shares rises to over 7%, for telecommunication companies and utilities it is around 8% and for bank shares it is above 9%. Furthermore there is evidence that stocks paying high dividends are associated with higher returns over time as retained earnings are often wasted and dividends reflect confidence regarding actual and future earnings. Of course there is no such thing as a free lunch – so the key is to focus on companies that have a track record of delivering reliable earnings and distribution growth over time, where dividends are not reliant on significant leverage and the yield is not high only because there is something wrong with the company.

Corporate debt is a good option for those who want higher yields than government bonds and term deposits but don’t want the volatility that goes with the sharemarket. For Australian corporates, investment grade (i.e. top quality companies) yields are now around 6% and lower quality corporate yields are higher.

Australian real estate investment trusts (A-REITs) used to be a popular alternative to bank deposits but fell out of favour in the global financial crisis as their yields proved unsustainable partly due to excessive debt. However, A-REITs have now refocussed on their core businesses of managing buildings, collecting rents and passing it on to their investors – all with lower gearing. A-REIT yields, at around 6%, are currently the second highest in the world amongst REITs (after France) and the sector seems to be more stable (falling only slightly during the recent correction).

Unlisted commercial property also offers attractive yields, around 7% for a high quality, well diversified mix of buildings, but into the low double digits for smaller lower quality property. Not bad when inflation is around 2%.

Finally, listed and unlisted infrastructure offers yields of around 6%, underpinned by investments such as toll roads and utilities where demand is relatively stable.

Concluding comments

With yields on shares up and yields on bonds down, shares offer a decent return premium for long-term investors despite short-term uncertainty. However, for those who can’t take a long-term approach and/or want to take advantage of short- term opportunities, outcome-based approaches or focussing on income yield beyond bank deposits are worth considering.


This information is of a general nature only and neither represents nor is intended to be personal advice on any particular matter. We strongly suggest that no person should act specifically on the basis of the information contained herein, but should obtain appropriate professional advice based upon their own personal circumstances including personal financial advice from a licensed financial adviser and legal advice. RI Advice Group Pty Limited ABN 23 001 774 125  AFSL 238 429.

After Tax Income - Comparing Dividends from Shares to Cash

It is believed that there is currently around $1.4 trillion in Australia in Cash and Bank Deposits in Australia as some investors have sought a safe haven.  This is more than the total value of assets currently held in the entire Australian Superannuation System.

For those seeking income from their investments however, the below chart shows the after tax income from investing $100,000 in 1995 into a basket of Australian Shares (blue bars) compared to investing into a cash deposit that returns the RBA cash rate which is currently 4.25% (red bar).

The green bar is the level of income received when the value of franking credits from Australian shares is included.  Franking credits from the tax already paid by a company before paying a dividend, which is effectively returned to the taxpayer through the tax system.  Effectively this means that with the company tax rate at 30%, a 5% fully franked dividend equates to around 7.1% in pre-tax income when those franking credits are included.  We have produced a video on our YouTube channel for those who wish to explore this aspect in more detail.

This chart clearly shows that for long term investors seeking income, that the after tax income from Australian Shares measured since 1995 is now providing around 3 times as much income compared to an investor who invested the same amount into a cash deposit.

Given that there are very juicy dividends on offer in the current investment environment such as Telstra paying 8.6% fully franked dividend (which is equal to more than 12% on a pre-tax basis), this is food for thought.

Note: Advice contained in this article is general in nature and does not consider your personal situation or needs. Please do not act on this advice until its appropriateness has been determined by a qualified adviser.  While the taxation implications of this strategy have been considered, we are not, nor do we purport to be registered tax agents. We strongly recommend you seek detailed tax advice from an appropriately qualified tax agent before proceeding.  The information provided is current as at March 2012.


Fixed Interest Investors – Wealth Hazard Ahead

APRA News Article for October 2010 edition

With investment markets uncertain, many investors have sought the fixed interest markets as a safe haven.  While term deposits and cash management trusts can generally be considered safe, particularly with the current Government bank guarantee, this article examines fixed interest investments that are often held in managed funds and allocated pension/superannuation funds that could actually lose money in a rising interest rate environment.

The fixed interest funds we are referring to here are usually called “Fixed Interest” or “Capital Stable” funds and form part of the investment menu of managed funds, allocated pension funds and superannuation funds.

But how can it be that a fixed interest fund can lose value?  The underlying investments of a fixed interest fund typically include long dated Government Bonds.  In Australia the Government currently issues 10 year bonds.  If an investor purchased a Government Bond and held it until it matured in 10 years time, then the investor would receive their capital back at maturity assuming that the Government was not insolvent.  So far, so good.

Fixed Interest funds usually (or should) price their investments daily and it is with this point in mind, that investors in these funds can lose value in a rising interest rate environment.  To highlight this point, consider an investor who purchased a 10 year bond for $100,000 with an interest rate of 5%.  The investor receives $5,000 of interest each year.  Should interest rates move up to 10%, the investor would only require $50,000 of capital to generate the same level of income.  When fixed interest investments are valued daily, it is this logic that is used to determine the current value of a bond.  The principle is simple, fixed interest investments can increase in value when interest rates fall, and can lose value when interest rates rise.

Information sourced from Eurostat, International Monetary Fund and Bloomberg show that forecast annual Government Budget deficits around the world for 2010 – 2012 will be around USD $8 trillion (assuming budget balances are converted into US Dollars using the exchange rate on 12th May 2010).  The IMF has forecast in its Economic Outlook in April 2010 that these deficits are to be financed by a limited pool of savings.  The IMF forecast that the combined global current account surplus positions for 2010 – 2012 are around USD $3.8 trillion.  This means that it is forecast that governments around the world will require $8 trillion of funding over the next 3 years, but the savings pool is forecast to be less than half that.

This can only result in competition for debt from Governments around the world and the simple forces of supply and demand tells us that this can only lead to increases in interest rates.

Linking back to the effect of rising interest rates on fixed interest investments, below is a chart prepared by Magellan Financial Group showing the loss of value of Government Bonds assuming a rise in long term interest rates of 2% and then by 4%.  You will see that the value of an Australian 10 Year Government Bond would drop by 24.9% in the event of long interest rates rising by 4% (light blue bar), and would fall in value by 13.6% if long term rates increased by 2% (mid blue bar).

The message here is clear, Government debt around the world exceeds available savings and is extremely likely to put upward pressure on long term interest rates.  Investors should assess the impact of rising long term interest rates on any fixed interest investments they hold as a matter of urgency.

Author of this article is Mark Draper, from GEM Capital Financial Advice.  Further investment knowledge is available on the GEM Capital website –

For those wanting to complete presentation from Magellan Financial Group about the issue of rising long term interest rates, please either ring (08) 8273 3222 or email your request to This email address is being protected from spambots. You need JavaScript enabled to view it.