Zurich’s Patrick Noble ponders the new dynamic of banks trying to manage the expectations of politicians and mortgage holders and wonders if cash is still the answer for investors.
Relief at last? While last week’s interest-rate cut was almost a foregone conclusion, its magnitude was nevertheless a welcome surprise to many across broad sectors of the economy.
And, with inflation well within comfort levels for the Reserve Bank and a more subdued growth outlook, there’s reason to believe more rate cuts remain on the cards over the course of 2012.
As is the norm these days, not all of the benefit has been passed on to mortgagees. To date the Commonwealth Bank of Australia has passed on 0.4 per cent and National Australia Bank 0.32 per cent.
No doubt more debate will be heard over the coming weeks, but recent commentary suggests an interesting landscape, where banks try to manage the expectations of politicians and mortgage holders, while going toe-to-toe to win over depositors.
It is true that Australian banks continue to generate strong profits. The half year results of Australia and New Zealand Banking Group and Westpac on balance have met market expectations, though declining net-interest margins give some insight into the challenges facing our financial sector. High wholesale-funding costs and weak credit demand continue to be problematic, but the battleground for deposits has also seen profitability suffer.
For investors who have had entrenched cash as the cornerstone of their portfolios over the past few years, this creates something of a conundrum. On the one hand, Australian financial institutions are competing aggressively to attract deposits, but on the other it is in an environment where returns will potentially come under pressure with the prospect of further rate cuts.
Can cash carry it?
Is cash still the answer? As with all asset classes, cash will continue to play a role. But as the market goes through its cycle, it is likely the dependence on cash will eventually diminish. How long that cycle will be, of course, depends on timing, something we all acknowledge is notoriously hard to do.
Yet anecdotal shifts in asset allocation suggest this isn’t stopping many investors from giving it a go. They had too much equity exposure prior to the financial crisis and, as a result, have minimal exposure today. But here’s an unfortunate truth: despite a choppy market, Australian shares have delivered a return of 9.8 per cent per annum over the three years to 30 April 2012.
A well-diversified portfolio remains a good starting point to mitigate risk. But for those who remain cautious on equity markets, investing in low-volatility equity funds is another way of gaining exposure to shares without riding the highs and lows of market sentiment.
A share portfolio that is able to utilise exchange-traded options can be managed to generate attractive levels of income at lower levels of volatility than the overall market.
Options give an owner the right, but not the obligation, to buy or sell shares within a given timeframe and agreed price. As such, the ability to defer buy and sell decisions can have obvious benefits. A portfolio can buy some protection against market falls or sell some market exposure to generate additional amounts of income.
The financial crisis was a painful reminder that equity exposure does include risk. Yet anchoring portfolios to the experiences of 2008 neglects the risk of not achieving longer term savings goals. As banks prepare to do battle for savings, a sensible approach to equities can focus investors on winning the war.
Patrick Noble is a senior investment strategist at Zurich Investments.
