Time to get off the downhill rates ride

Two important developments took place during the week as we look at the yield decisions that are facing many self-managed funds and smaller retail investors.

I had anticipated that the big rise in bank shares in the last three months was caused by self-managed funds and smaller retail investors cashing in their bank term deposits and investing in bank shares. But I was yarning to the Westpac people, who this week were studying some broad movements on their share registry to determine just where the latest buying has come from.

And it seems that while the steady decline in the number of retail Westpac investors has been reversed, in the three months to the beginning of May only an additional 5,000 smaller retail investors joined the Westpac share registry. This was not a major buying force.

Westpac has just over 500,000 smaller retail shareholders, who hold around half the capital. Accordingly, those extra 5,000 people represent only a 1% increase. Of course, if it was repeated at each of the next three quarters you would be looking at an increase of 4% in retail holders It was clear from the Westpac share registry the big buying has come from either local or foreign institutional shareholders.

My guess is that the trend that Westpac has picked up on its share registry will be duplicated in the other major banks. The big banks have been apprehensively looking at their local term deposit support as interest rates have been falling. And so, when term deposit rates fell from below 6% they nervously looked to see if there was an exodus of term deposit money. There was not.

And when term deposit rates fell below 5% the banks once again feared an exodus and again there was not.

Now we are about to bridge the 4% mark and the similar apprehension will take place. The vast bulk of term deposits in major banks is either one year or less than one year. So it would seem that smaller investors have ridden the bank term deposit rates down. I am disappointed that more investors didn’t lock in longer-term deals given the clear indications that interest rates were going to fall. As a result, this must be creating enormous angst in those who need interest income to maintain their standard of living. The fact that term depositors are riding rates down is confirmed by Commonwealth Bank, which announced it had lifted the share of local deposits within its overall funding from 63% at December to 65% in March.

Interest rates below 5%, let alone 4%, are not good long-term returns, particularly for those who are providing pension income from self-managed funds.

It means that there is a substantial amount of money that is getting more and more frustrated by lower interest rates, and which may spill over into bank shares despite the rise in their price. I don’t think bank dividends are in danger, and the government is planning to increase the pace of tax collections for companies in the next few years, which will increase the need for corporate bank loans.

But clearly the higher bank shares rise, the greater the risk. Australia’s problem is that there is a shortage of strong yielding stock, which is pushing up the high yielding share prices. And here, potentially, the good news is that there seems to be a unanimous view amongst both the government and the opposition that we need a big acceleration in infrastructure investment and that superannuation should be part of it.

The government is looking at whether it should have tax incentives to encourage superannuation funds to invest in infrastructure. I am a little wary of this because it can sometimes mask inferior securities – give me better infrastructure securities . If the government wants to attract superannuation funds then it must develop securities that have only limited risks, and not the crazy securities that have been put forward in Sydney and Brisbane.

The trouble is that infrastructure securities are about two years away, because it takes that long to get the projects going and, of course, there is no income until they are built. I believe longer term that infrastructure and its returns are going to be an important part of those funds that are providing pensions. But this is ahead of us.

If you are in the position where you are about to see your deposit rates fall below 4%, then I think it is time to take some action . You can buy some bank shares (NAB has the highest yield) or bank hybrids to increase your returns.

But also have a look around at the smaller banks for returns that are higher than the majors. Remember that providing you invest less than $250,000, they are government guaranteed. My guess is that in the unlikely event of a collapse each account will be treated as a separate guarantee, but if you are dealing with smaller institutions it is best to keep your total family exposure below $250,000 so there is no doubt.

As of the end of this week the small banks were not being aggressive . The best rates for 12 months was NAB’s UBank at 4.61%; Bank MECU offered 4.65% for three years, and Westpac offered 4.65% for five years. When dealing face-to-face, always try and negotiate a higher rate with your bank when you are investing over $20,000.

It is only when depositors revolt against lower and lower rates that banks will respond. Currently they can borrow from off shore markets at lower interest rates than the local term deposit rates, despite the local decline. But they do not want to lift their overseas exposure .

Each of the majors has a policy of having a very strong Australian deposit base and they have been able to drive deposit rates down and not see an exodus of funds. I believe that the time is approaching when this will happen. But I have been wrong in the past.