The life and times of term deposits

The Reserve Bank of Australia's (RBA) decision to set the country's interest rate at historic lows is good news for home buyers, but it means low yielding returns on investment for self-funded retirees.

Official interest rates stand at 2.25 per cent, with speculation the RBA will cut the rate later in the year.

Despite consecutive rate cuts since the global financial crisis (GFC) in 2008, it has not hindered the popularity of cash investments.

The safety and semi-liquid nature of some cash investments have not only prevented the demise of these products, they have in fact risen in popularity, according to Investment Trends research.

"From our ‘2014 Adviser Product and Marketing Needs Survey', over the 12 months to August 2014, planners were typically placing 15 per cent of their new client inflows into cash and term deposits," Investment Trends analyst King Loong Choi said.

"By August 2017, they are expecting this to decrease to 12 per cent of inflows."

Total cash deposits in Australia rose to $1.7 trillion, or by eight per cent over the 12 months to October 2014, according to Investment Trends' 2014 product needs report.

"We typically find investor and planner return expectations for the market tend to have a much bigger impact than interest rates." - King Loong Choi

IOOF portfolio manager for cash and fixed income, Juanita Escobar, said she expects authorised deposit taking institutions (ADIs) will continue to have sound liquidity and funding requirements, and believes cash and term deposits will remain popular in Australia.

ING Direct's manager for superannuation, Tim Hewson, said that although rates were much lower, the spread of the rate applied on term deposits and the bank swap rate were higher than pre-GFC levels.

"The driver for that being the need for banks in the new regulatory environment to want to drive a higher percentage on their balance sheet," Hewson said.

"The market has changed in recent years in terms of other options for banks to fund themselves. So wholesale funding has come back into play, and securitisation has been more broadly used in the market."

Hewson said this, along with the banks having spent the last five years or more readjusting the balance sheet, meant the spread had changed.

Rate of interest

On a global scale, the US Federal Reserve said in March that their interest rate, which remains unchanged at 0.25 per cent since 2008, might increase.

Chair of the Federal Reserve, Janet Yellen, said that if there was a rate change, the Reserve would take into account its global impact.

RBA Governor, Glen Stevens, said in February that while a lift in US interest rates would cause disruption, it should be received positively.

"In America, interest rates are extremely low, but the central bank is talking about raising them. In Australia, interest rates are very low, and the central bank has talked about lowering them further," Stevens said.

Similarly, despite the possible US federal rate rise, Escobar predicts Australia will not follow suit and cash investments will not be affected.

"I personally believe Australia is part of the current divergence in monetary policies on main economies. While the Federal Reserve is considering raising rates [through] ‘data dependent' [factors], Australia will cut rates further in 2015," she said.

When it comes to influences on investment products, Choi said "we typically find investor and planner return expectations for the market tend to have a much bigger impact than interest rates."

But he noted that the rate itself tended to play a bigger role for planners to search and use term deposits.

Investment Trends' Investor Intentions Index Report for March showed 39 per cent of investors expected a decrease in interest rates at the March RBA board meeting, six per cent expected an increase, and 55 per cent expected the rate to stay the same.

According to Escobar, IOOF's cash management trust was at $1.7 billion with 36 clients since 31 March 2015. Term deposits accounted for 34 per cent in funds under management (FUM) with nine out of 18 ADIs holding term deposits.

ING Direct's 2014 financial results report found the bank is currently booking $32.4 billion in retail deposits, with 36 per cent of retail savings in term deposits.

ING Direct said that there was an increase in term deposit growth from 2007 to 2008 but growth had plateaued since 2014.

"If you're thinking about cash and the fact that under $250,000 they've got a government guarantee it's hard to think of anything that is less risky. It is certainly something you don't get with equities or fixed income, it's truly counterpart focused." - Tim Hewson

Since the GFC Hewson found that self-managed superannuation funds (SMSF) were becoming more risk averse, adding there was an appetite to create more liquidity in a bid to take a more defensive approach.

Hewson also noted the older generation were more inclined towards cash investments.

"At the age of 25 to 55 we're looking at an allocation to term deposits and cash at around 10 to 11 per cent. Once you get into the higher age bracket of 55 to 65 it jumps to 30 per cent within our retail super product," he said.

"This is also broadly consistent at 28 to 30 per cent in our SMSF sector."

Hewson said despite being in a rate cut environment there was no significant change in popularity for cash and term deposits.

"If you're thinking about cash and the fact that under $250,000 they've got a government guarantee it's hard to think of anything that is less risky. It is certainly something you don't get with equities or fixed income, it's truly counterpart focused," he said.

Alternatives

Since Australia's previous historic interest rate low of 2.5 per cent in August 2013, AMP Capital has been encouraging its investors to look at alternative investments to generate yield.

AMP Capital head of retail and corporate business, Craig Keary, said the company has been educating financial advisers and investors on how to generate yield.

"We ran a campaign and ran a lot of seminars around the country for financial planners and their clients about alternative ways for clients to invest," Keary said.

"As a consequence we did see clients put money into some of the other alternatives such as our corporate bond fund, infrastructure fund, and our ‘income generator' fund — a diversified multi-asset fund."

Keary also said that there was growing interest in infrastructure and direct property as it can deliver good yield.

"Infrastructure is quite a good asset class when it looks at inflation, and some of those assets re-price on inflation rises in CPI [consumer price index] and that's quite attractive as well," he said.

AMP found retirees were also starting to look at their own life expectancy and realised that they actually needed growth as well.

"As we've seen interest rates coming down it triggers a conversation on whether to renew term deposits or not," Keary said.

Choi noted that as people started to move away from cash and term deposits they have started to invest more of their money into growth assets such as listed investments and managed funds.

Another alternative to cash and term deposits that is gaining traction are cash exchange-traded funds (ETFs), which has been growing by 50 per cent per annum, according to BetaShares co-founder and managing director, Alex Vynokur.

Vynokur said it was the fastest growing segment of the managed funds industry in Australia with $780 million in FUM at BetaShares.

ETFs are traditional managed funds that trade on the ASX like normal shares.

"The big benefit of ETFs is that they provide investors access to a variety of asset classes and strategies," Vynokur said.

"Investors have the benefit of liquidity on an instrument that trades on the exchange but at the same time they have the benefit of the regulatory protection of a traditional managed fund."

Vynokur believes cash ETFs would be an easier alternative to cash and term deposits for advisers.

"For example advisers that look after 100 or 200 clients in term deposits look after them individually and it's quite a laborious process. With the cash ETF you can achieve a higher rate of return on cash without the laborious part of trying to roll term deposits or negotiating moving money from one bank to another," he said.

"There's a lot of paperwork involved with that and the benefit of the cash ETF is that we do the leg work for investors basically. They can invest in the ETF but it is our job to negotiate with the banks."

Vynokur said that despite the growth of cash ETFs, BetaShares are still the only company offering the product, and added he did not know if any firms were thinking of offering them.

Regulation changes

While term deposits have continued to be popular, IOOF did see a two per cent drop within their FUM from February to March 2015.

Escobar said that although this seemed like a drop it was actually an internal rebalance in their cash management trust. She said that cash notice accounts were being implemented into portfolios.

Cash notice accounts were launched in 2013 by some ADIs, with Escobar noting that it was in preparation for the Basel III regulation change.

"Basel III has been prompting ADIs to innovate, and create new products such as the cash notice accounts," she said.

Basel III is the Basel Committee on Banking Supervision's regulatory framework on bank capital adequacy, stress testing, and market liquidity risk. It aims to improve the banking sector's ability to absorb shocks from financial and economic stress.

From 1 January 2015 the Australian Prudential Regulation Authority (APRA) implemented the liquidity standard APS 210 for all ADIs. The APS 210 is based on the Basel III and its main requirement focuses on the banks' liquidity coverage ratio (LCR).

Banks must now hold low-yielding high-quality liquid assets (HQLA), like term deposits, for at least 30 days. The depositor also has no legal right to withdraw their funds unless they are experiencing hardship.

Cash notice accounts revolve around depositing cash from 31 days to one year. If, for example, a depositor opens a six month cash notice account and gives notice that they would like to withdraw they need to wait six months from the time of notice.

"So you will know when you are going to receive money as soon as you give notice," Escobar said, adding that the interest rates on these accounts were based on the RBA's interest rate.

Vynokur highlighted that after the Basel III regulation was implemented he found that a lot of advisers had started to adopt BetaShares' cash ETF.

"It is a way to get exposure to cash because it is a lot more efficient and gives you the benefit of liquidity without locking up your money," he said.

Gazing into the future

Despite low interest rates since 2008, it looks like cash and term deposits are here to stay because depositors see it as a safety net.

"I think pre-GFC allocations to cash may have been too low," Hewson said on the rush to cash during the GFC and the continued risk-averse environment.

Term deposits continue to be popular because they are easy to place in banks, they bring certainty for the older generation, and they are easy to understand, Hewson said.

"If you're moving into equities and bank stocks because of yields then you might be getting a slightly higher yield but you take on equity risk that you don't get with term deposits," he said.

"If you're looking at fixed income you're taking on capital risk in addition to taking on credit risk."

But this could all change if the government decides to implement a bank deposit levy that could inevitably affect depositors.

In response to the Treasury's proposed plan in March the Commonwealth Bank of Australia said on April 1 it could affect consumers through higher fees or lower interest rates for deposit accounts.

Commenting on the future of cash and term deposits, Escobar said: "I personally expect term deposits and other types of short term assets to continue to be offered and will continue to be popular.