Investors have been frustrated by the low return on cash for many years now and the situation may worsen if, as some expect, the next move in official interest rates is down.

Most banks have played on the complacency of many customers, who will simply hold the cash they need to have accessible at near zero or very low rates. Product innovation from banks in this area for retail customers (especially the majors) has been minimal. The traditional cash management trust structure has waned as its higher costs have been brutally exposed in a very low cash rate environment.

Of course, investors can be thankful they can still access short- and medium-period term deposit rates at levels well above the 1.5 per cent official cash rate and a significant amount of money has headed that way. Cash and near cash investments can have a valuable role in a portfolio, both for access and liquidity and as a buffer and defensive asset in difficult market conditions.

Banks do seem to have been prepared to sharpen their pencils in setting up cash arrangements for various investment platforms but it doesn’t seem investors are seeing the real benefits from these. Those are mainly going to platform margins. Surely it seems a bit odd that some platforms are earning their biggest profit margins on the cash held than on any other investments on their platform.

Fortunately, the available cash options for investors have been expanding with some of the more innovative developments in cash-based exchange-traded funds. Having said this, investors may need to access them directly or through very inexpensive platforms to get the real benefits.

A pioneer in this field has been the BetaShares Australian High Interest Cash ETF (ASX: AAA). This ETF, which has now been around for more than five years, offers exposure to major bank term deposits and has a yield just over 2 per cent. It is about $1.3 billion in size. There have been some questions around the modest mismatch between the use of term deposits and immediate cash availability but this has not been an issue in the ETF structure and has been well managed by BetaShares to date.

Stockspot, a fintech that offers direct portfolios of ETFs, recently moved to offer an unlisted savings vehicle that accesses the AAA ETF.

More recent ETF offerings such as iShares Core Cash ETF (ASX: BILL) have been closer to traditional cash management trusts in terms of their underlying holdings (but with much lower fees) and are gradually attracting investor support.

Cash/near-cash ETFs listed on the ASX:

table from asx

Source: ASX

While the above vehicles offer low risk, based on their underlying asset holdings, it is easy for investors to get tempted to place cash into other fixed interest options, often looking at yield alone (or past performance) and without understanding the additional risks that come with them. Those two primary risks are credit risks and duration.

In the listed space, there are now about 15 fixed interest ETF options. Of course, taking on the credit or duration risk (or both) that these or unlisted fixed interest products carry is totally sensible as part of a diversified portfolio. However, it can be dangerous for an investor’s strategy or ability to meet objectives when such products are used as cash replacements. If investors need access to the money or are saving for a specific near-term goal, cash ETFs such as those discussed above, or normal cash accounts and term deposits, are usually the preferred option.

Having said that, another issue that is often underestimated in the listed space is the impact of transaction costs and spreads. While brokerage rates have come down in recent years, it is still not uncommon to hear of minimum brokerage rates on listed transactions of as high as 1% or $100 (whichever is higher). If an investor buys $10,000 worth of AAA to hold for a year, $100 brokerage on purchase and sale will eat up their entire 2 per cent interest earnings. Some smaller and less liquid ETFs may also have larger bid-offer spreads that add to the cost. Note, I am assuming here the investment is not held on a platform where an additional ongoing administration fee is also likely to be paid.

A warning for the yield chasers

There will always be investors and advisers keen to chase higher yields for their cash holdings outside low-risk conventional cash offerings or the new ETF cash space. In response, there will always be products created to meet this demand, even though many of these come with little transparency about the true underlying risks.

Indeed, looking back over recent decades, it is easy to underestimate how many of these more unconventional savings/yield investment options have led to losses for investors. From the multitude of failures amongst finance company debentures and unsecured notes, to higher-yield mortgage trusts and various high-yield credit funds, all of these were at times seen as low-risk cash alternatives. Many of these were ultimately backed by residential property, helped by the perception, at least until recently, that property prices don’t fall. While investors have since become a little wary about this premise, given recent property market conditions, this development may have opened the way for promotion of other risky cash/yield options backed by other asset classes.

IPO Wealth is one unlisted wholesale-only fund offering that has come up on my radar recently. It equates itself as an alternative to term deposits and is offering rates of 3.25 per cent to 6.45 per cent for investment periods of three to 60 months.

Indeed, if you google term deposits, IPO wealth’s “Term Deposit Alternative” ad link to its website appears as the second entry. This offering, while available only to sophisticated investors (with a minimum $100,000) or those with over $500K, has raised more than $80 million and is being promoted with recent full-page advertisements in the financial press and most notably by TV personality Peter Switzer.

Yet the ultimate underlying investments backing this fund and these returns – often via convertible notes – is a collection of about 20 private equity, mainly fintech and often start-up businesses selected by what seems to be a relatively small and untested investment team with no identifiable performance history. I say “what seems to be” because disclosure about the actual underlying portfolio, process and team is quite limited.

Investors in IPO Wealth’s range of options seem ultimately to be accepting returns modestly above bank term deposit rates while taking on the possible downside risk of what could be classified only as highly risky or even speculative investments.

I am not aware of any financial planners who have supported this product to date, but the company has indicated it will be targeting them this year.

These types of complex products masquerading as simple ones suggest that the whole concept and definition of sophisticated/wholesale investor needs to be reviewed and overhauled. Most of us know investors with more than $500,000 to invest who are far from sophisticated.

An increase in the number of offerings in the cash space is a welcome development and investors should benefit, albeit in the context of very low rates overall. Yet investors still need to be wary in considering whether transaction and other costs eat away at the benefits for some. More importantly, investors and advisers need to resist being tempted by aggressive exposure to credit, duration or structural product risk that could result in poor performance or capital losses in certain environments.

For true cash holdings, investors need to stick with more conservative offerings where the key characteristics are accessibility and security of capital. Extra return is nice but very much a secondary issue.

Dominic McCormick is an investment consultant and observer with a focus on the listed investment space. His writes exclusive insights aimed at financial advisers for Professional Planner.

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