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It was nice while it lasted and it’s been a wonderful safe haven in a world of financial turmoil in 2008. But super fund investors will have to start searching elsewhere for another darling, as the days of cash being king are sadly numbered.
Two nails have been hammered into the coffin in the last week. We’ll come back to the one that occurred first in a moment.
The second occurred yesterday when the Reserve Bank carved another 100 basis points from the official cash rate. That’s a total of 300 basis points (3%) in just four swings of the axe since September. The RBA’s benchmark rate now sits at 4.25%, the equivalent of the lowest point it has got to in the last couple of easing cycles.
(However, it doesn’t mean that those with mortgages have got their equal lowest rates. In the last part of the raising cycle, banks added extra on the way up and haven’t cut one for one on the way down.)
As always, the cheers from homeowners and the general news media are loud. But for those on the other side of the fence, particularly those in super who have benefited from large cash holdings in recent times, this was no Christmas present. And others might actually be fearful for lost income.
As those with SMSFs know more than most, falling interest rates mean falling returns for the hub of the super fund – the bank account. In headline terms, the accounts paying the top interest rates have fallen most of the 2% that had been cut in September, October and November. Most, but not all. Competition between banks has meant that, in many cases, cash accounts have only suffered about three-quarters of that fall, or 1.5%.
It can be safely assumed that interest-paying accounts won’t pass through the vast majority of this most recent cut to account holders quickly.
This is a major reversal for returns on cash. Prior to September this year, we had not really seen interest rate cuts for cash accounts since the last easing cycle started (and finished) in 2001. And that was a relatively gentle two percentage points over 11 months (the last couple of which were arguably solely in response to the September 2001 terrorist attacks). We have not seen cuts of the current speed and this nature in a long, long time.
The rises were so consistent that, to the end of last financial year, cash had worked its way to become the second best performing asset class for the year. Research house Lonsec reported cash returned 7.34% in the year toJune 30, 2008. (It was beaten only by the return from international fixed interest with 7.91%.) It wasn’t hard to beat the shocking negative returns of Australian and international shares and property.
Returns on cash management trusts have fallen from between 6.5 to 7% to around the 5% mark recently. That’s likely to take a full hit to 4% in the coming days and weeks (depending on other competitive pressures).
But then comes the second event. The government’s deposit guarantee kicked in on November 28. The distortions in the market are now becoming clear and there will be impacts on some historically popular SMSF favourites.
It’s been an exhausting couple of months for executives at several of the major financial institutions, as they’ve been forced to respond to the changing landscape and rush products to market. Macquarie Bank has hastily pulled together a ‘cash management account’, because its ‘cash management trust’, the largest managed fund in Australia and apparently the cash base for one-third of all Australian SMSFs, wasn’t going to be covered by the deposit guarantee in a way that would have kept the product super competitive. Adelaide Bank, and others, have been forced to do something similar.
In most cases, what the customer will see and what the rush of product is hiding, are some of the detailed issues that the Rudd Government’s decision has caused.
Macquarie’s Cash XL (launched earlier this year), plus their CMA (launched in the last few weeks) and traditional term deposits will all qualify for the government guarantee. For depositors with less than $1 million, there would not have been an issue. For depositors with more than $1 million, Macquarie has said it will cover the 70 basis point cost of the insurance to stay competitive that applies toMacquarieas an AA-rated bank.
Adelaide Bank, however, as a serious competitor with a lower credit rating, has an insurance premium of 150 basis points and could not competitively offer the same.
You can expect the products on offer in the CMA, online account (the low-functionality, but high interest paying accounts) and term deposit spaces to remain highly competitive and at the top end of the ballpark.
However, CMTs are likely to fade into the background. They simply won’t be able to maintain competitiveness in the face of the ‘insurance’ bill, because under the trust structure, it is only the first $1 million of the fund (not of each individual client) that is covered without the insurance. The insurance cuts in when the fund itself reaches $1 million. And that’s a potentially big cost for CMTs, which can hold billions of dollars.
WhileMacquarieis going to absorb the insurance cost for its high flyers (those with deposit balances above $1 million in their guaranteed products), the same won’t apply with the CMT. The cost to fund investors will be about 80 basis points. Add that to the 100 basis point cut from the RBA yesterday and the cash returns for the CMT are expected to fall below 3.5% very quickly.
Inflation, need I point out, is still officially running at 5%.
For SMSFs, the implications are clear. You have to make new investigations into your super fund’s cashbox. The leading products of even just six months ago could be struggling under the new landscape.
Thanks to interest rates being slashed by the Reserve Bank, cash is unlikely to produce much of a positive return this financial year. Even at half the rate, it may still be a better return than equities or property. But a tremor underneath the basic account types for SMSFs means you need to do a quick health check of the basis of your super fund.
Bruce Brammall is a financial adviser and author of Debt Man Walking (www.debtman.com.au)