What Lies Beneath?

Record low interest rates in Australia are tempting frustrated, yield-seeking investors into products where the risks can be obscured. New products often are marketed as solid, cash-like instruments that offer regular, predictable returns. But we’ve seen this movie before, and it doesn’t always end well.

Think back to 2007. With interest rates low around the globe (but not as low as now), the then governor of the Reserve Bank of Australia, Glenn Stevens, warned that in the search for yield, many investors were unwittingly straying out to the frontiers of risk.

“A long period of interest rates being low and fairly steady, however well justified it might apparently be by short-term macroeconomic fundamentals, also causes behaviour to change,” Stevens said in a speech in Hong Kong.1

“The search for yield eventually explores some fairly remote territory – be it more pension fund or retail money going into hedge funds, the rise of private equity funds, or the use of ever more exotic strategies by various managers to generate returns.”

Now as we enter the 2020s with record low interest rates in Australia, we again see ads for products that appear to blur the line between traditional, safe bank deposits and risky property loans. Credit funds, hybrids, high-yield bonds and private debt are pitched in glossy full-page ads at investors who formerly might have kept a chunk of their savings in term deposits.

In response to this, consumer advocate firm CHOICE recently said: “It is concerning that some financial institutions are using slick marketing techniques to mimic the advertising of safe savings accounts to sell people into complex and risky financial products.”

Ironically, this slick marketing is appearing just as some people whose money was stuck in frozen funds a decade ago finally emerge from the wreckage. Before the 2008 Global Financial Crisis (GFC), investors flooded into mortgage trusts to capture the attractive yields. They were offered immediate redemptions but, when the crisis hit, investors discovered their investments were illiquid and their funds were frozen. During the GFC, the mortgage fund sector was particularly hit hard, with $11 Billion of investor funds frozen. Several well supported funds collapsed altogether.

This isn’t to say another crisis is around the corner, but it does serve as a reminder that during periods of very low interest rates, as we are seeing now, yield-deprived investors can overlook risk in their scramble for return.

The truth is higher yield does not come free. It is the flipside of different types of risk, some of which may be hard to quantify. This can include credit risk – the chance of the issuer defaulting on their obligations – or illiquidity, where it is hard to get your money out.

Of course, not all these advertised products are inherently bad. But it may be worth talking to us about whether they are appropriate for you, given your circumstances, goals and risk appetite. A bank deposit and a mortgage fund are not equivalent beasts.

There also may be other choices you can make that don’t leave you out on the frontier of risk without a compass to get back home.

One choice is to take on more diversified exposure in other asset classes that offer higher expected returns. Yes, there are risks here as well, but you can cushion that by being highly diversified.

If you really don’t want to bear additional risk, there is also the choice of moderating your consumption expectations. This obviously can involve some difficult decisions, but if it allows you to sleep better at night it may be worth it.

Wanting additional income is understandable. But you need to be wary about some of the promises being made by product manufacturers who are taking advantage of frustrated investors searching for higher yields in the current low interest rate environment.

Ultimately, your best option is talking this over with your adviser, assessing your asset allocation and seeing what choices you have available without taking you to uncomfortable areas.

On the surface, high yield can look attractive, but you always must ask what lies beneath.

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1. Stevens, Glenn; 2006; Risk and the Financial System, Reserve Bank of Aust

This advice may not be suitable to you because it contains general advice that has not been tailored to your personal circumstances. Please seek personal financial and tax/or legal advice prior to acting on this information. Before acquiring a financial product a person should obtain a Product Disclosure Statement (PDS) relating to that product and consider the contents of the PDS before making a decision about whether to acquire the product. The material contained in this document is based on information received in good faith from sources within the market, and on our understanding of legislation and Government press releases at the date of publication, which are believed to be reliable and accurate. Opinions constitute our judgment at the time of issue and are subject to change. Neither, the Licensee or any of the Oreana Group of companies, nor their employees or directors give any warranty of accuracy, nor accept any responsibility for errors or omissions in this document. Gordon Thoms and David Conte of Calibre Private Wealth Advisers are Authorised Representatives of Oreana Financial Services Limited ABN 91 607 515 122, an Australian Financial Services Licensee, Registered office at Level 7, 484 St Kilda Road, Melbourne, VIC 3004. This site is designed for Australian residents only. Nothing on this website is an offer or a solicitation of an offer to acquire any products or services, by any person or entity outside of Australia.

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