Investors should remain wary of piling back into term deposits despite sharply higher rates now on offer, Salt Funds Management argues in a new paper.
With some longer-dated term deposit rates now north of 4 per cent and short-term gross returns nudging above 3 per cent (or about four-times the level recorded last July), the traditional safe haven asset class is becoming increasingly attractive again.
Greg Fleming, Salt head of global diversified funds, says in the new report: “Given this development, what is the rationale for an investor tolerating the asset price volatility in a diversified income vehicle, rather than simply ‘parking cash’ in a financial institution with sound credit ratings, like a High Street bank?”
Indeed, Reserve Bank of NZ figures show term deposit holdings of local residents have ticked up steadily since March this year rising from just under $140 billion to almost $150 billion at the end of July.
Ultra-low interest rate records set in the wake of COVID-19 emergency monetary intervention early in 2020 had seen local term deposit holdings sink from a high of more than $170 billion to a low of $139 billion last October.
However, Fleming says diversified income funds still hold several advantages over term deposits for yield-focused investors.
He says income funds tend to provide more stable yields, better liquidity, greater flexibility to respond to market changes and a stronger ability to offset the impact of inflation compared to term deposits.
“The risk of locking investable monies away in bank deposits is less that one will receive an inferior interest rate or income yield, and much more, that those funds will not be available for rapid deployment into other market opportunities when the current inflation-driven volatility begins to subside,” the Salt study says. “… Inflation is painfully high at present but holding too much Cash is not a solution – rather, it is a form of ‘money illusion’ which can potentially lead to a more serious erosion of an investors’ future purchasing power. Staying active and staying diversified is, in our view, the wiser course.”
Several NZ investment managers, including Salt, created income funds during the long period of low interest rates ushered in by the global financial crisis, catering to the demand for high-yield as term deposit rates faded (ultimately to under 1 per cent at the short end).
Managers met the income needs by including a broad range of assets, typically taking on more risk by allocating to equities and listed property.
But recent research from Auckland investment consultant, MyFiduciary, shows a wide variance in asset allocation among the NZ income fund universe.
For example, the equity component of the five income funds in the MyFiduciary analysis ranged from about 15 per cent to 50 per cent while one manager held almost zero cash compared to a high of more than 60 per cent in a rival product.
Fleming says investors should take care to understand the underlying risks of specific income fund strategies.
“… all credible financial advice providers stress the need for extensive research, before adopting an Income-focussed strategy, as there are multiple pitfalls for the inexperienced,” he says.