Mabule Setoaba, Investec
In times of low-interest rates, it’s important to understand what risks investors are taking on by seeking additional yield. Despite the low rate environment, placing cash with a reputable institution can help investors achieve their goals.
Recent events in the market have highlighted some of the issues investors need to think about. In particular, falling interest rates have eroded the attraction of many cash investments.
After a few years in which one could earn better returns on a cash product than in the equity market, investors in cash products have had a tough time over the last year. A three percentage point cut in the repo rate since the start of the pandemic, combined with a sharp rise in inflation have further reduced some of the attractions of bank deposits.
This presents a potentially major problem for investors who live off the proceeds of their cash investments and who are, at current rates, earning a below-inflation return. While some will switch to riskier assets, the volatile equity market may not appeal to those at certain life stages (not to mention other extremely volatile assets, like cryptocurrencies).
The dangers of “reach”
Many cash investors will look towards products like money market funds or income funds to fill the gap. These funds will often offer what appears to be a higher rate than cash deposits, providing that “reach” for yield that they require.
Despite perceptions, money market and income funds are not without risk. To earn an attractive yield, the fund manager will invest across a blend of fixed and floating rate paper, in a diversified portfolio of instruments issued by banks, corporates and the government. Investors in these funds thus face the risk of some capital loss if one of the issuers defaults.
It should be noted that when placing money in a bank deposit with one of SA’s leading banks, that the risks are not zero either. However, investors can draw considerable comfort from two sources. The first is capital adequacy. Since the Global Financial Crisis of 2008, banks around the world have been required to hold more capital across a range of assets. While SA was little affected by the crisis, local banks have followed the approach of their global counterparts. The end result is that SA’s leading banks are very well capitalised, making the risks of default extremely small.
A second reason is the likely introduction of a deposit insurance scheme, which will protect private depositors in the event of a bank default or insolvency event. The Financial Sector Laws Amendment Bill, which includes the creation of such a scheme, was presented to Parliament in March.
In addition to fully understanding the risks investors are taking on when choosing the different products, there are a few other questions worth asking, such as:
Is there a trade-off between interest rate earned and accessibility? Often a higher rate is offered on a deposit in return for the funds being locked up for an extended period. Other deposits have notice periods of 30 or more days, before the investor can enjoy access. It’s wise to consider accessibility before being drawn into a higher rate. Even then, it’s worth looking around to see where a decent rate can still be found on products that offer easy accessibility.
Leading from this, how flexible are the options? Investors will be attracted by features that work in their favour, such as no minimum or maximum balances, the ability to increase the amount invested and so on. Investors may also want to earn interest for each extra rand deposited. They may also want to choose between receiving the interest earned or reinvesting it. These features make it worthwhile to look closer at each offer.
Is there a role for a foreign exchange cash deposit? Deposits in US dollars, euros or pounds may seem appealing, but as the last year has shown, there are periods in which the major currencies depreciate against the rand, while in most of these currencies, the rates are even lower than the rand. An offshore currency deposit does make sense, however, where there are commitments overseas, for example, school or university fees in those currencies.
Can you manage your after-tax return expectations? As noted above, rates are at multi-year lows, making returns look a lot less attractive when compared with returns in equities, for example. Investors will need to align expectations when choosing a cash investment of any kind, while also understanding the risks behind the higher yields that may be out there in the market.
In answering the above questions, it’s also important to work with a bank or financial institution that can innovate and be flexible in providing cash investments that work for both intermediaries and investors.
In conclusion, while a low-interest rate may make life uncomfortable for investors who rely on bank deposits for their income, there’s no reason to turn away from cash. Cash remains an accessible way to preserve capital in a volatile market and as such, has a key role to play in any portfolio.