Rates are the boiling water and investors are the frogs! What to do?

Mark Todd

Bank of China

 

Recently the RBA advised that the Term Funding Facility (TFF) was to be expanded, enabling Banks to borrow cheaply for years to come. The impact of the cheaper funding was immediate for investors who traditionally invest in bank debt. From fund managers who regularly buy senior debt through to investors and corporates who buy term deposits as a means of finding conservative investments. 

The unfortunate reality is that due to the RBA policy and the increased pool of cheap funding options, banks do not want your money. Banks are approaching the tragedy of Covid as an opportunity to provide much needed community support. Without suggesting any cynicism banks are aware this is the time to step up and help customers with their mortgages and debt burdens. The banks have been keen to remind the community that they are not just money making machines - but integral partners in the community. 

The collaborative approach to customers does not actually extend to investors, the message is clear. Banks are sorry, but the facts are, it’s cheaper to fund elsewhere - and will be for years - so we can’t use your funds. It may get worse … banks, post- Royal Commission, need to lend responsibly, which means they need to lend to those who they are completely confident will not get into any trouble in the next decade. In the event, they do, they’re mitigating the risk of being litigated against either in the courts or trial by the press. This is a big ask, and it leads to increased demand for equity from the borrowers. 

There is one area the banks can lend and that will be State and Federal institutions. In a beautiful example of catch 22: the banks can borrow cheaply from the Central Bank of Australia to fund Australia’s growth, but due to the Australian regulators’ response to the Royal Commission, they are more likely to lend to Australian Government entities - as they are safer and less likely to complain. 

The end result is that the assets you or your fund manager habitually invest in are shrinking. Over the next few years there will be less assets that are conservative which offer rates that are worthy of consideration. While rates grind lower, the water heats up, and investors are left scrambling for reasonable options. The equity market continues to rally and it becomes harder to deploy fresh funding. In the event there is a significant sell off, investors will clamber for safe haven … and possibly not double down in equities! 

When it comes to conservative investments we have negative investment jaws: too many buyers and not enough product! 

What to do 

The first and most vital point is to disclaim, disclaim, disclaim, any products or strategy that is offered in this article may be a product or strategy that BOC has an interest in. Investors need to do their own research before they come up with a new strategy. 

FX Options 

The main game up until the election of the next American President and possibly after, is going to be FX rates. A close election result to either side will probably see some decoupling from the US on the expectation that a close result confirms the country is divided and open to more volatility. A landslide win to Biden - will probably sustain a bid tone in $USD on the assumption of a consumer/electoral bump in economic activity, there may be a feel-good rally if Americans buy into the ‘American exceptionalism’ narrative. In the unlikely event there is a landslide win for Trump - investors may head for home as they wait to see how an under-siege President responds. Trump, in a landslide would be compelling must-see TV, to say the least. 

Dual Currency Investments 

A Dual Currency Investment is a structured deposit product which enables an investor to increase returns commensurate to their risk appetite. It may suit clients who have exposures in more than one currency.  Such as investors who are either long $USD assets and want to wait before reinvesting or investors who are prepared to buy $USD if the Australian dollar rallies. By combining a traditional deposit with selling an FX call option, investors are essentially taking out a deposit that repays in one of two currencies, depending on the prevailing FX rate at maturity. The premium received on the call option is paid, along with interest, at maturity, to give a higher rate of return. 


 This is not for everyone - and investors need to be fully aware of the risks. Assuming the investor is satisfied, the combination of FX Options with deposits does enhance the possible outcome for the investor. But do note that these type of products are generally available for sophisticated investors only and most of the Australian banks offer it. 

Strategy 

In my opinion, rotate your assets and make the money work harder! If you are not trading credit directly, then it is important to find a fund manager who is active - and importantly - is set up to be active. Look at the larger fund managers and see how big their team is as a larger team can find more opportunities. Similarly, a larger team has better access to issuers and a larger team usually has a better relationship with the global price makers. If your investments are with a small fund manager then the only question you have to ask is “what is their edge?”. Are they experts in a very specific niche? If they can’t explain to you in terms that you can understand - then you need to rotate - not just your assets, but your managers as well! 

Conclusion 

We could be in these rates for another decade. Even the Central Banks do not consider the conversation about ‘higher rates’ … and we are about to go through a very painful post-Covid recovery. Time is on the side of the Central Banks and not on the side of the investors. The lower rates environment will squeeze the returns on conservative investments. Therefore, find a means to create more velocity in your portfolio - or change your personal mandate, so that you can invest in different products - otherwise, the heat from lower rates will have a somnolent effect on your portfolio and with devastating consequences.

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Bank of China may have a commercial and financial interest in the assets mentioned in this article. Bank of China does not provide investment advice - and as such, this commentary should not be relied upon as advice. Investors should seek its own independent and appropriate advice that is suitable for their investment needs.

Mark Todd
Head of Fixed Income
Bank of China

Mark joined Bank of China in 2019 as Managing Director and Head of Fixed Income Sales, bringing with him over 25 years’ experience in FICC Sales. Prior to joining BOC, Mark was Head of Core Customers within NAB’s FICC Sales division.

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