For cautious investors, the safest option has usually been touted to be cash. COVID-19, however, threatens to turn longstanding monetary policy on its head. Even in Australia, there’s been discussion of the possibility of negative rates as shutdowns and social restrictions constrain normal economic activity.
For people exploring ways to keep their wealth safe, this closes off a secure sanctuary for funds. While current monetary policies that flatten gains might be driving people to seek out substitutes, there are close-to-cash alternatives for a range of risk profiles. These can come with slightly higher exposure and returns but may serve as satisfactory, close-enough replacements for savvy investors.
Super funds and other institutions are encountering the challenge of near-zero and close-to-negative returns for their cash options. This highly liquid class is traditionally viewed as a secure, stable choice.
However, the Reserve Bank of Australia’s actual (not target) rate is just 0.13% and analogous instruments like short-term bank bills are delivering just 0.10%. In this environment, superannuation funds are encountering a major hurdle when it comes to offering their members cash options with meaningful returns after fees and costs.
One substitute might be a term deposit. Some of these are still yielding as much as 1%. However, anecdotal evidence suggests some in the banking sector are rejecting institutional investors who are looking to park bigger amounts into term deposits. The reason is that these players are sitting on a lot of funding and deposits already. Term-deposit yields were as high as 1.7% following the March cut, and there are more risk-averse depositors looking for a safe haven, thanks to the pandemic.
Meanwhile, limited growth in commercial and residential credit, also due to the coronavirus and possibly due to increased competition from alternative lenders, acts as a constraining factor. For further context, the RBA’s new term funding facility allows them to borrow large amounts cheaply, at just 0.25%.
Alternatives to cash
This crushing of cash is an intentional, strategic element of the RBA’s overall monetary policy to drive economic activity. By eliminating gains on low-risk deposits, households and businesses are more likely to look for other investment solutions. So what are the cash-similar selections out there?
Covered bonds or higher-ranking corporate bonds provide better yields but also a higher risk of loss depending on the deemed creditworthiness of the issuer, though the issuers do provide a pledge of protection. For example, you can buy an AAA-rated BOQ covered bond that is returning 1%. These are tradeable and don’t lock you into contracts of at least one month, unlike term deposits.
Senior unsecured bank bonds (BBs) are another possibility, similar to bank bills and negotiable certificates of deposit as a choice. Lower potential for default, high liquidity, and daily traceability, and eligibility for the central bank’s repurchase (or repo) facilities make these an outstanding substitute for those seeking liquidity and earnings. BBB+ rated BOQ Bbs are now returning up to 1.3%.
Other possibilities include company issued bonds, some of which are now eligible for the RBA’s repo facilities. Poorer credit ratings, higher potential for loss, illiquidity, and no government guarantees make these a less attractive consideration. Similarly, subordinated or Tier 2 options pay around 2.5% to 3.0%, with higher volatility, greater illiquidity, and no eligibility for the central bank’s repo facilities. Other proxies could be hybrids (4% to 4.5%), which are liquid and tradeable on the ASX but come with their own hazards.
Central banks in Japan and various European countries have imposed negative interest rates in recent times. Australia has introduced near-zero rates to encourage more lending and to stimulate economic activity, to counter the impacts of COVID-19. In theory, when this happens, the institution can charge depositors a fee just to keep their money in an account, and borrowers can earn a small amount on their loans. For those hoping to keep their money safe, this might cancel out what is traditionally considered rock-solid vehicles. However, the astute who are seeking secure alternatives to ride out the pandemic does have choices, including hybrids and other types of investments.
Author bio: Luke Fitzpatrick has been published in Forbes, The Next Web, and Influencive. He is a guest lecturer at the University of Sydney, lecturing in Cross-Cultural Management and the Pre-MBA Program. Connect with him on LinkedIn.
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