News & Insights

AFR: Rate cut yield trap fear for nervous savers

Another cash rate cut could set a trap for yield-starved savers seeking better returns on their capital than those those on offer from banks, real estate and most balanced funds, according to fund managers.Savers and investors chasing higher dividends to offset falling income could drive up the price of income stocks, pushing down stock yields, or chase special dividends and overpay for additional yield, they warn.

Savings and lending rates are being slashed as lenders anticipate the Reserve Bank will cut cash rates from a record low 1.5 per cent at Tuesday’s meeting.

Fund managers are warning about traps as shadow banks match recent mortgage cuts by the big four and mutuals and slash their rates by up to 70 basis points, pushing lending rates to new record lows.

Good news for property buyers is creating fears for savers and those on fixed income, such as the nation’s 3.8 million retirees, as interest rates on savings and bonus savings accounts range from nil to promotional rates of 75 basis points, which is less than half the rate of inflation.

Top rates for one-year term accounts with a minimum of $25,000 range from about 1.3 per cent to 2.3 per cent, according to Canstar, which monitors rates and fees.

Returns on term deposits and products linked to bank bill rates are also likely to continue falling, according to Don Hamson, managing director of Plato Investment Management, which has more than $1 billion under management.”Income securities or bank hybrids are priced at a margin to bank bill rates and we have already seen 90-day bank rates fall more than 60 basis points this year,” Mr Hamson said.

“An investor needs to combine yield with other considerations, such as risk and return.”

— Andrew Hair, chief executive Acadian Asset Management

While interest rates were hitting all-time lows, dividends paid by Australian companies had never been stronger, he said.

“Ironically, the ALP threat to franking has actually caused some companies to flush out excess franking credits prior to the end of the financial year, providing Australian income investors – including retirees – with a record level of dividends.”

Corporate profits in 2017-18 rose by 8 per cent and dividend payments were up by more than 13 per cent.

Ninety per cent of S&P/ASX 200 reporting June 30 full-year results declared a dividend, and of those reporting a dividend, 70 per cent increased it.

This is helping drive 12-month returns on Australian equity income funds to nearly 17 per cent, according to analysis by Mercer Australia’s recent investment survey.

Mr Hamson, whose income fund has returned 15 per cent over the past five years, adds: “A cut in interest rates – while it won’t lead to an increase in dividend income – will also lead to increased investor demand for dividend-paying stocks, raising the capital value of some.”

Can signal good value

Andrew Hair, chief executive of Acadian Asset Management, whose high-yield fund is up 13 per cent over the past 12 months, said high yield can signal good value but also may be a sign of distress.

“An investor needs to combine yield with other considerations, such as risk and return. When a stock has an unusually high dividend it can flag that there may be other issues that is being reflected in the stock price,” Mr Hair said.

Fund managers warn income-starved savers could be caught in yield traps.  AFR

Investors “blindly” investing in companies because they have traditionally provided high dividends may be overpaying, said Joanna Nash, Acadian portfolio manager.

“You also need to be careful on chasing special dividends, as often the share price may jump by more than the dividend when it is announced, which means you could overpay for the additional yield,” she said.

Lenders continue to cut headline mortgage rates, putting more pressure on already low returns for savers.

Shadow lenders Pepper Money and Resimac are reducing rates by up to 70 basis points across a range of mortgage products. Pepper is cutting rates on its near-prime full documentation range of products, including loans for borrowers with only 5 per cent deposit. Resimac is cutting two-year fixed rates.

Three of the four majors and several smaller lenders, including ING, have slashed rates since the election by up to 50 basis points or locked in borrower discounts in packaged financing products, which also include credit cards and insurance, by more than 130 basis points. ING reduced variable rates for new owner-occupiers by 17 basis points for loans of more than $150,000.

Greater Bank, a NSW-based mutual, has cut one-year fixed rates to 2.99 per cent, which slashes more than $13,000 a year – or $762 a month – off loan repayments for a $1 million owner occupier with a 20 per cent deposit.

 

Written by Duncan Hughes

Originally published in the Australian Financial Review.