Interest rates have been falling to the point now where they’re at historic lows and asset values have risen accordingly, enhancing super funds’ returns.
But according to Mercer’s President Pacific Region and CEO Australia, David Bryant, we may be seeing the beginning of a change in central bank interest rate policies which will have serious consequences.
He warned that we are going to face a period, that unless the central banks manage “perfectly to ease” our way out of extraordinarily low interest rates, super funds are going to show “not much return on where they are” for a couple of years.
The reality, he maintained, was that when interest rates go up, asset values fall, equity markets fall, bonds fall and infrastructure falls. The problem this time round will be that the historic rate fall and yield convergence run has gone on so long and so hard that while usually you’d swap from equities to bonds, that option may not be available.
“We’ve had crowded trades for seven or eight years, longer tenures in infrastructure [and] they lack liquidity,” he said. “None of those markets will provide safe havens and all of them will go down. Now, the question then becomes, what’s the pace at which they fall?”
When interest rates start increasing, he said, it’s not just one increase you need to think about because the next increases start getting priced in.
“The question is not what does a 25-basis point increase mean, it’s what does a 75- to 100-basis points rise mean,” he said.
“When you’re running on yields at 50 points, 1 per cent, 2 per cent, 100 basis points is a lot,” he said.
He went on to warn that there was a lot of value at risk.
“How do you hedge that away?” he said. “What you need to do is to shorten duration, and to understand if you have sufficient liquidity. This is where stress-testing should be considered. You need to be able to identify and consider the positive and negative impacts across the short and long term.”
“A diversified portfolio is also important, and active management can play a role in identifying market inefficiencies to find those opportunities to protect capital and generate alpha.”
“We’ve got to remember, even in superannuation, we’ve got two degrees of choice. One is choice of fund and the other one more critically is investment choice. So if you have a lot of members who say, look, I want to get out of growth or balanced, and I want to go to your conservative option, you end up with pretty significant asset mismatches and very rapidly changing liquidity profiles in some of those.”