Investors need to make their money work in low interest rate environments

While the lowest interest rates in 38 years may be providing welcome relief to the over-indebted consumer, many cash flush investors find themselves having to settle for lower income returns.

According to Sean Segar, Head of Product: Nedgroup Investments Cash Solutions, in an investment environment where capital growth is likely to slow after several boom years, investors need to take yield more seriously than ever.

“Losing out on 1% when interest rates were 12% was not as big a deal as forfeiting 1% of yield with call at 5% – which effectively means giving up 20% of the potential return,” he says.

The table below illustrates the importance of maximising yield over the longer term. For example the impact of an additional 1% yield on a R100 investment over 30 years results in a significant 33% lift in investment value. Such a large differential would certainly not be overlooked by a professional money manager.

“The volatile markets have highlighted the need for investors to take account of risk, liquidity and that high interest rates should not just be accepted at face value, as they are a reflection of the state of the lender and their ability to make interest and capital repayments,” says Segar.

Segar explains that Citi Bank is offering Japanese yen investors 0.03% per annum for a one-year fixed deposit. However, investors are demanding around 26% per annum for investing in 10-year Greek Government paper – post the bail out. “This highlights the wide spectrum of available returns as determined by the capital markets once risk has been factored in,” says Segar.

According to Segar, the sub-prime crisis resulted in numerous borrowers defaulting on their interest and capital obligations, but after a period of post-crisis reflection and restraint this reckless yield chasing is reappearing.

“Fortunately, South Africa has largely avoided participation in the hazardous pastime of indiscriminate yield chasing, the blood sport of the investment world. Ignorance, greed and desperation are the main causes of this tragedy which can be avoided by investors utilising credible, well managed and regulated income funds and accepting the fact that interest rates are low at present,” he says.

Segar says in South Africa there is a good spread of interest bearing investment options available - ranging from bank deposits to property funds.

“The domestic unit trust fixed income range includes 111 funds excluding real estate. The bulk of income investor assets comprise the R230 billion residing in money market funds. Bank deposits dwarf this amount by a factor of around 10 times. Money market funds and bank deposits yield less than income funds due to the fact that they offer immediate access to investor cash,” he says.

However, Segar says in a surprisingly high percentage of cases, investors are incurring an opportunity cost in terms of forfeited yield for the luxury of having immediate access to the cash. Most of the time this is neither needed nor utilised and hence the investment is considered ‘lazy’.

“There is a jump in complexity, risk and yield from money market funds to income funds that many investors are reluctant to make. This results in investments not working as hard as they could, and yielding sub-optimal income,” he says.

According to Segar, one relatively new solution available to retail investors are funds that adopt the strict credit guidelines prescribed by the Financial Services Board for money market funds, but are able to invest in slightly longer-dated paper to enhance yield.

He gives the example of the Nedgroup Investments Core Income Fund, which was made available to retail investors in January and enjoyed excellent flows since September last year. According to Segar the fund has almost quadrupled during this period attracting net flows of around R3 billion.

According to Segar the fund has the attributes of both money market and income funds, enabling investors to improve their yields without taking on additional credit risk. Investors also have easy access to their funds with only a day’s notice required, he says.

“With low interest rates set to continue for the foreseeable future, low risk investors looking to optimise their income, sweat their cash and retain the ability to access their funds at short notice must look at some of the more innovative solutions on the market today,” says Segar.