While seven years have passed since the peak of the global financial crisis, the shadow it casts over monetary and financial conditions lingers on.
Create a strategy for Not-For-Profit Investors:
In most advanced economies cash interest rates are currently close to zero – offering no return for investors. In Australia, our official cash rate has been cut to 2%, which is not surprisingly, leading investors to seek opportunities for higher returns.
The ‘perfect storm’ for cash rates
Over the last few years, to stimulate growth in their respective economies, the US, Japanese and European Central Banks have deployed Quantitative Easing (QE) measures. Such measures include reducing interest rates close to zero and boosting liquidity into the financial system in an attempt to stimulate confidence, spending and economic growth. Additionally in 2015, inflation rates were lowered as a result of the drop in prices for oil (below $50) and some of the major commodities such as iron ore, copper and other base metals. The combined impact of these forces has seen bond yields and cash rates decline substantially.
In Australia, our growth has also been transitioning from the intense resource-led investment boom we experienced over the last decade, to a more moderate pattern driven by domestic factors. This means our growth is now below its natural trend. In response to this, the Reserve Bank of Australia (RBA) has tried to stimulate domestic demand and depreciate the Australian dollar (AUD) by reducing interest rates to the current low of 2% – and there are strong expectations the RBA will make further cuts to rates if economic growth does not move higher in 2015/16.
Quest to Enhance Returns
How can investors enhance their investment returns in the context of very low cash rates?
Diversify into higher returning assets
Investors should consider diversifying into other asset classes such as: Australian and international equities, unlisted global infrastructure, domestic unlisted property and alternative assets. Such asset classes represent enhanced return opportunities and cater to the typical longer-term investment horizons of not-for-profit investors. While these asset classes may have a greater level of capital volatility than cash, the longer-term income and capital return profiles would complement cash investments. As always investors should consider their own risk appetite and if necessary seek advice from an investment professional before moving out of their cash and bond investments.
Increase Credit Exposure
One strategy is to take on additional credit exposure to capture yield enhancement - for example, purchasing domestic or international corporate debt securities. When buying these corporate exposures, it is important to understand where the investment sits within the capital structure of those companies. At the moment, a lot of domestic investors are excited about Australian hybrids which are high yielding equity-type investments. These securities sit just above equity in the companies’ capital structure meaning any equity market decline will impact prices. When buying an Australian bank hybrid, investors also need to consider the total credit risk; bank cash deposits, a bank equity holding and a hybrid holding, all may have credit exposure to the same entity.
Just like moving into new asset classes investors need to consider their risk appetite and seek professional advice before moving into higher yielding bond/equity investments.
Not-For-Profits have the advantage
One of the biggest challenges for investors is managing asset price volatility over shorter-time periods. Most not-for-profits are usually set up for perpetuity with an annual spending requirement. This means they have a much longer time frame to invest, allowing them to consider investments in long-term growth assets such equities, property, infrastructure and alternative assets. Even though these investments may have higher short-term volatility, they can provide solid long-term growth as well as good levels of annual income yield.
The other key advantage for not-for-profits is that they are tax exempt and receive full cash value for franking credits. Not only does this mean these investors should be indifferent to capital and income returns, but they can generate extra yield by investing in Australian equities and companies that deliver high franking credits. Mercer believes it is essential that each tax exempt investor fully utilise their tax exempt status in the management of their Australian equities portfolio.
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