Making room for cash
Despite the low interest rate environment, SMSF trustees are still hanging tight to their cash investments. How do you find the right home it?
At time of writing, cash rates are at a record-low two per cent, where they have been since May.
According to a survey by comparison website finder.com.au, all 23 out of 34 respondents – economists and commentators – expect the cash rate will start rising in 2016, while the remaining eight are forecasting the cash rate will rise beyond 2016.
The Reserve Bank of Australia (RBA) is likely to cut rates again this year, according to AMP Capital chief economist and head of investment strategy, Shane Oliver.
Mr Oliver said that Australia's poor business investment outlook, high Australian dollar, weakening commodity prices, and a likely loss of momentum in housing prices will warrant further monetary easing at some point before year end.
If the RBA retains its easing bias, and cuts the cash rate later this year, Mr Oliver believes, "bank term deposits are likely to remain unattractive and could fall even further”.
Mr Oliver argued that growth assets which provide decent yields will remain considerably more attractive to investors.
“This includes commercial property and infrastructure but also Australian shares which continue to offer much higher income yields – and more stable income flows – than bank term deposits,” he said.
The investor market looks to be responding to the dire outlook for bank deposits. According to a Rice Warner report – which analyses the market of personal investments in Australia as at 30 June 2014 – total cash and term deposits will reduce from 35 per cent to 30 per cent.
Similarly, and somewhat surprisingly, there has been a decline in the number of SMSF trustees holding cash in recent months.
According to Multiport’s 2015 SMSF Investment Insights survey, which looks at around 2250 funds, a sample of the SMSFs Multiport administers and the investments they held at 31 March 2015, cash holdings and short term deposit holdings are on a noticeable decline.
The current level of 16.5 per cent is the lowest level recorded since commencement of Multiport’s quarterly surveys in the year 2007.
Low interest rates continue to make cash less attractive as an investment so maturing term deposits are not being replaced with new term deposits, according to Multiport.
Further, joint research conducted by The SMSF Association and NAB found the average proportion of cash held by SMSF trustees in their portfolio has fallen to 15.9 per cent from 19.7 per cent in 2013.
On the other hand, the average allocation to Australian equities has risen since 2013, from 36.1 per cent to 42.6 per cent.
“It is clear that the prevailing attitude among trustees is de-risking their SMSF portfolio and that holding a substantial proportion of cash in their portfolio is one way of doing so,” the research stated.
“However, the record low cash rate of 2 per cent, which previously remained at 2.5 per cent from August 2013 to January 2015, has likely contributed to trustees moving funds out of cash to other asset classes, particularly equities.”
In spite of recent trends, however, cash holdings remain relatively high in SMSF portfolios. The March 2015 ATO SMSF statistics show cash and term deposit holdings represent almost 30 per cent of all total net Australian and overseas assets. This has been a consistent theme for SMSF investors for many years.
Speaking to SMSF Adviser, Eric Blewitt, general manager at CommSec Adviser Services, said despite the low interest rate environment, CBA has noticed demand for cash accounts remains strong.
“It seems counter-intuitive given the low interest rate environment. What we’ve actually seen over the last 12 months, is we continue to see strong growth both in new accounts, new cash accounts, as well as balance growth from new accounts as well as increasing balances from existing accounts,” Mr Blewitt said
“The general sentiment among SMSF investors still predominantly seems to be one of caution, given everything else that is happening around the world and that has been running through our news cycles,” he added.
Mr Blewitt also noted that the levels of excess cash in SMSF portfolios are again starting to build and peak, after three years of being in decline.
“[This is] driven by the uncertainty in the conservative investor’s mind. SMSFs, they’re uncertain about the Australian economy despite the numbers, there’s debt concerns in the EU, although that might have dissipated a little bit,” Mr Blewitt said.
“Given those type of global factors, given 70 per cent of SMSFs are actually either in transition to retirement or actually in some form of pension, their main focus is capital preservation, not capital growth. So you [think] it’s counterintuitive with interest rates at all-time lows, but people are cautious about investing in active assets.”
Finding the right account
With SMSF trustees reluctant to give up their love of cash, what qualities should advisers be looking for in a cash account?
The obvious starting point is the rate that’s on offer, with a small differentiation in the rate on offer making a significant difference given the long-term horizon of superannuation.
However, outside the obvious, there are some other key pointers for advisers and clients alike to keep in mind.
Speaking to SMSF Adviser, director and private wealth adviser Chris Morcom at Hewison Private Wealth said the quality of an institution needs to be paramount in the selection process.
“For us is it has to be an A-rated institution – it simply has to be highly rated institution. It also has to be subject to the Australian banking regulations and therefore also part of the retail deposit guarantee for balances under $250,000,” Mr Morcom said.
“It’s a lot of money, and you’ve got to think, you want that to be safe. So you’re immediately going to go to institutions that are solid, dependable, and you know they’re not going to blow up overnight,” he said.
“Why? Because you’re holding cash because you want to be safe, you’re not holding cash to get high rate of return.”
This seems like basic advice for any adviser who knows their onions. But more and more, clients are putting pressure on their professional advisers to consider bank alternatives which offer higher interest rates, like credit unions.
Many credit unions have well-established reputations and are ramping up their offerings to SMSF investors. However, Mr Morcom warns both clients and his peers against the temptation.
“I’m not someone who will chase half a per cent by putting money into a credit union or something like that, because I think you’ve got to be aware of the risks you’re taking with that money - where is it being on-lent to? That’s a question you need to think about,” Mr Morcom said.
“We had a client come to us with money in a local credit union, and I said to them ‘I think you should pull the money out.’ They were quite happy with the interest rate, I said ‘well you might be happy about the interest rate but I’m not happy with the risk,’” he said.
“The collapses that have happened are very sad for those people who are involved in them, but they serve as a warning for everyone else as well.”
Given the low rate of returns for SMSF investors holding their money in cash, advisers should be using accounts that are easy to administer, to ensure the return is not further dwindled down by administration fees.
Professionals should therefore be warned against chasing high-interest accounts which are also an administrative burden.
“Because we administer over 500 SMSFs for our clients, we need to ensure that we’ve got highly efficient [accounts]. So we want to have a cash account that we can have data uploads from, we want to be able to easily balance those bank accounts - they need to be highly functional,” Mr Morcom said.
“A lot of the internet high-interest savings accounts can only be operated by individual, that’s highly inefficient for a practice like us who has got over 500 SMSFs. We can’t be wondering which client to get the password from, it’s not going to happen that way,” he added.
“For example there are some cash providers who won’t deal with third parties. We can’t even open up those accounts for our clients because the institution won’t deal with us.”
<subhead> Gently, gently
With some cash accounts barely beating the rate of inflation, it’s important for your clients to recognise that essentially cash is not an investment, Mr Morcom suggested.
Mr Morcom said Hewison Private Wealth views cash merely as a liquidity enabler, and relays that message to its SMSF client base.
“It forms part of the investment portfolio because you need to have liquidity in your investment portfolio, but… unless you’ve got an absolute reason why you need to have high liquidity in your affairs, I can’t think of a really good reason why you should have significant amounts of your wealth held in cash,” Mr Morcom said.
“I really strongly believe in developing appropriate asset allocations to achieve objectives. That does require an exposure to cash, but not a significant exposure to cash,” he said. “We’ll have on average it’d be somewhere between five to 10 per cent of our client’s portfolios would be in cash, maximum.”
Mr Morcom suggests gently showing clients what can be achieved with a portfolio which steers away from being cash-heavy, while still satisfying their risk profile.
“If you’ve got a well-constructed asset allocation in assets that have got reliable, providing you with reliable income, and that income meets your needs, so long as you’ve got sufficient liquidity to meet any capital items that are coming up in the near term horizon, you’re really impacting your overall portfolio returns by having so much in cash.”
“And when we show them what we can do with a portfolio of great investments, that really then reduces the need to have cash, and makes the cash decision a little bit easier.”