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Seven ways to beat the rba

Want to beat falling term deposit rates? Here are seven options, but remember the old adage about no free lunches.

People living on income from their savings face an uncomfortable truth. Any investment that is not a bank deposit or government guaranteed bond carries added risk. The TANSTAAFL, better known as ‘there ain’t no such thing as a free lunch’, is the reality of investing in a low interest rate world.

Over the last decade, the merit of bank deposits has changed dramatically. For example, in December 2009, Westpac offered a 5-year term deposit paying 8%. It attracted $2 billion in a week and Westpac quickly closed it. That term deposit sat in the retirement portfolios of thousands of Australians until 2014, and it’s been a rapid downhill for rates and income ever since.

At the time they grabbed the Westpac deal, few people would have thought they would never see such a good rate on a bank deposit again in their lifetimes, even if they live for 100 years. For guaranteed income, it’s more ‘lower forever’ than ‘lower for longer’.

The risk appetite of every person, or acceptance of the reality of TANSTAAFL, varies according to their circumstances. Some older people with good savings financing their later years and perhaps the need to buy into a retirement facility cannot risk losing their capital. They may need to accept the 2% returns, or really, zero returns in inflation-adjusted terms.

Other people with more lifetime options can accept some risk for extra return, so let’s survey the income landscape in the listed market on the ASX. Across Listed Managed Investments, Exchange Traded Products and its mFunds service, the ASX identifies 92 Australian and 38 global fixed income products. It’s a far bigger range than most investors realise, and we will highlight some of the more popular in this article.


1. Cash

The least-risky listed products are Exchange-Traded Funds (ETFs) which invest in bank deposits with short duration. The largest is the BetaShares Australian High Interest Cash ETF (ASX:AAA), while UBS issues the UBS IQ Cash ETF (ASX:MONY) with similar assets. Blackrock issues iShares Core Cash ETF (ASX:BILL) which can invest in a wider range of short-term securities. All these ETFs have returned around 2% in the last 12 months, but their returns will fall in line with cash and bank bill rates.

2. Cash-enhanced and floating rate notes

Staying in short-duration investments but adding securities with slightly better returns are the VanEck Vectors Australian Floating Rate Bond ETF (ASX:FLOT), the BetaShares Australian Bank Senior Floating Rate Bond ETF (ASX:QPON) and iShares Enhanced Cash ETF (ASX:ISEC). The extra income comes from buying notes with maturities up to five years, but it comes with a little extra risk because prices of such instruments fluctuate more than cash or bills. Again, returns are likely to follow cash and bill rates.

3. Investment-grade bonds

Now the field really starts to expand as many fund managers offer bond funds which invest in investment-grade credits of BBB+ or better. With these high ratings, a diversified portfolio should produce acceptable credit risk, and the exposure to interest rates depends on the duration of the bonds. Each fund manager will accept different risks depending on their perception of the opportunities. There are also index funds which have lower fees but deliver no potential for outperformance.

Examples include Vanguard’s Australian Corporate Fixed Interest Index ETF (ASX:VACF) which invests in investment-grade Australian corporate (ie non-government) bonds, while less risky is Vanguard’s Fixed Interest Index ETF (ASX:VAF) because it also includes government bonds. Russell issues its Australian Select Corporate Bond ETF (ASX:RCB) and BetaShares has an Australian Investment Grade Bond ETF (ASX:CRED).

These funds usually introduce duration risk which benefits from falling interest rates, and therefore their one-year returns have been impressive as rates have fallen. But here’s where TANSTAAFL kicks in. Future returns depend on the movement of interest rates, and these funds will suffer when rates rise. The decision for the investor, therefore, is not so much credit risk as interest rate risk at this ratings level, although we saw in the GFC how ratings agencies don’t always understand the real risks.

4. High-yield products

As bonds purchased move down the ratings spectrum, default risk on lower credit quality names starts to become a major TANSTAAFL factor. The benefit of investing with a quality fund manager is their portfolio might include hundreds of issuers with no more than 1% of the portfolio exposure to one name, such that a modest number of defaults does not erode capital. However, in a severe economic downturn, the lower credit quality may cause losses. Investors need to weigh the merits of return versus risk.

Here we move away from ETFs to Listed Investment Products, and the individual fund characteristics vary. Operating in the global market across issuers in many different countries, credit qualities and industries is the Perpetual Credit Income Trust (ASX:PCI), which aims to hold 50 to 100 issues with an overall target return of the RBA cash rate plus 3.25% after fees, over the cycle. The Neuberger Berman Global Corporate Income Trust (ASX:NBI) is even more diversified with 450 global holdings, and it works on a declared annual distribution level, currently 5.25% paid monthly.

In Australia, the Metric Credit Partners MCP Master Income Trust (ASX:MXT) holds a portfolio of directly-originated Australian corporate loans, rather than buying public bonds, with a target return of RBA cash plus 3.25%. Gryphon’s Capital Income Trust (ASX:GCI) invests in asset-backed securities (or securitisations) issued in Australia and targets cash plus 3.5%.

Of course, with all these targets, they are not guaranteed but more like manager aspirations.

At this end of the market, skill and diversification play important roles to manage TANSTAAFL. The reason a manager can deliver 4% or 5% rather than 2% is some added risk dimension.

There are a few ‘notes’ listed on the ASX which don’t receive much attention, are unrated and not highly liquid, but their structure offers good investor protection. They are debt instruments backed by the assets of a larger Listed Investment Company structures. Two examples are NAOS’s ASX:CAMG and Whitefield’s ASX:WHFPB.

5. Hybrids

Hybrids have become a major part of the credit structure of many companies but particularly banks. They mix characteristics of debt and equity but come in a vast array of variations. It is not possible to summarise all the alternative choices here, but they are certainly not all created equally. Many can be mandatorily converted to equity in certain events, or have their coupon payments suspended.

Margins over the bank bill rate vary according to expected first call date, investor appetite and issuer funding needs, and they are lower in the bank capital structure than senior and subordinated debt, but above shareholder equity. While difficult to generalise, major bank hybrids currently offer up to 3% above the bank bill rate (including franking benefit).

For those who prefer not to face the idiosyncrasy of individual issuers or tranches, BetaShares offers the Active Australian Hybrid Fund (ASX:HBRD) with expert selection from the hybrid universe.

6. Inflation plus, balanced funds, equity income, property, infrastructure

Some of the best income opportunities on the ASX come with an acceptance of risk in other asset classes such as property, shares and infrastructure. Balanced funds provide combinations of assets to match risk appetites.

This is where TANSTAAFL dominates. While a fund might call itself ‘equity income’, it will invest heavily in shares with an income bias. Often, these funds are significantly exposed to the high dividend-paying stocks of financial companies such as the banks, and companies such as Telstra. There is the tradeoff. A bank might offer a current dividend of 8% including franking, but the share price could fall heavily in a market correction, and dividends may suffer in an economic slowdown.

Investors in this space must accept TANSTAAFL as the total return from good income may be outweighted by falling capital values.

Both real estate and infrastructure claim greater ‘defensive income’ characteristics than other shares. Listed examples in ETFs include the ETFS Global Core Infrastructure ETF (ASX:CORE) and SPDR’s DJ Global REIT ETF (ASX:DJRE), while in the active management space, there is the Magellan Infrastructure Fund (ASX:MICH) and AMP Capital’s Global Property (ASX:RENT). Some retail property such as shopping centres are struggling as more consumer demand moves online, while industrial property such as distribution centres benefits from the same trend.  

While assets such as Sydney Airport (ASX:SYD) or the toll roads owned by Transurban (ASX:TCL) have near-monopoly positions and strong cash flows, they are subject to regulations and changes in traffic levels.


7. Other listed products

Returning to products where most of the return is expected from income, there are two others worth mentioning:


To improve access to unlisted managed funds, the ASX has an execution service which allows investors to buy and sell managed funds through a participating broker. There are 221 mFunds holding almost $1 billion, of which 19 are Australian fixed income and 29 are global fixed income. Major brands such as Legg Mason, PIMCO, Schroders and AMP are represented.


Rather than investing in broad fixed income sectors or funds as most of the examples in this article, Exchange Traded Bonds or XTBs allow retail investors to choose specific bonds of borrowers who have issued bonds in the Australian wholesale market. Buying a bond of a single company removes the benefits of diversification.


Don’t forget the TANSTAAFL feeling

Many different offers and product structures will appear in coming months as the market satisfies demand by the billion from investors who were previously happy with term deposits and cash rates. Always remember those nine letters: TANSTAAFL.

Also consider investment costs. Placing only $5,000 in a listed product for a 0.5% yield pick up is only $25 a year, which barely covers brokerage and management expenses. Better to accept 2% on a term deposit. Take care with some cash-enhanced funds that stray into unusual securities without a reward for the risk.


Graham Hand is Managing Editor of the financial newsletter, Cuffelinks. As nabtrade is a sponsor of Cuffelinks, subscription will always be free to nabtrade clients.


About the Author
Graham Hand , Firstlinks

Graham Hand has over 40 years of experience in financial markets, including Group Treasurer and Managing Director Treasury roles at major banks. He ran a financial consultancy business for many years before spending a decade in wealth management at Colonial First State. In 2012, Graham was the Co-Founder (with Chris Cuffe) and Managing Editor of Cuffelinks, now Firstlinks, a leading financial newsletter with 80,000 Monthly Active Users. Morningstar acquired Firstlinks in October 2019 and Graham is now Editorial Director at Morningstar. Graham has written extensively for major financial publications, and two of his books, one on the banking system and one a novel, have been published.