5 minute read
HARBOUR SPONSORED CONTENT
from ASSET NOVEMBER 2020
by ASSET
Keeping portfolios afloat when interest rates are sinking
With downwards pressure on interest rates even stronger than it has been for the past couple of years, Investment Specialist, Shannon Murphy, sat with Head of Fixed Income, Mark Brown, to discuss how he approaches the challenge.
BY SHANNON MURPHY AND MARK BROWN
Murphy: The industry has been keeping an eye on low interest rates for a while now, but increasingly mum and dad investors are becoming aware of the downwards pressure on interest rates. What’s your take on the interest rate outlook at the moment?
Brown: New Zealand’s rates were at all-time lows in 2019. The Reserve Bank (RBNZ) had been trying to get inflation to lift higher after being persistently below target. Then Covid-19 hit, and suddenly the weakening economy and rising unemployment meant the RBNZ has had to act aggressively. It has various tools to push interest rates downwards; cutting the OCR into negatives has had a fair amount of media coverage recently. There has been a little less coverage of the funding for lending scheme concept, where they would offer cheaper loans to banks, who could pass lower funding costs onto clients. Used in tandem, these two initiatives would likely prompt lower term deposit and mortgage rates in New Zealand. What is not yet certain, is whether it will be necessary to cut rates in 2021. Regardless, interest rates are likely to remain low in the short to medium term.
Murphy: A lot of advisers I’ve been meeting with recently say clients have been flooding to them with maturing term deposits, and are worried about the low interest rates on offer. Many are around retirement age and need a portfolio which supports their lifestyle.
Brown: Term deposits have been a safety net for investors for a long time, and so it has been quite confronting for some people seeing them decline to below 1%. It does mean we are facing some serious challenges helping retirees to generate income from the savings they have built up over their lifetime.
Murphy: There is a widespread understanding that rates will stay low for a long time and may even go negative. Is the solution as simple as switching out of term deposits to something higher risk?
Brown: The idea of investing in equities has real merit, as you can access attractive dividend yields and benefit from capital gains over time. If you take a medium-term view and mentally prepare for bouts of probable volatility then you have a good chance of sticking to your discipline. However, I think it’s important to keep each client’s risk appetite front of mind. Human psychology and history tell us that risk averse investors have a proven tendency to bail out of volatile investments when markets fall, and selling near the bottom can be incredibly damaging to long-term returns.
Murphy: How do you see that working in an asset allocation sense?
Brown: I like to avoid looking at growth and defensive income assets as two distinct buckets, as if there is a binary choice between one or the other. It’s important to consider classic growth assets to help boost returns, but also a more diverse range of income generating assets. As finance theory tells us, a portfolio broadly spread across many different uncorrelated asset types can have a very powerful outcome.
Murphy: You manage Harbour’s diversified Income Fund; what sorts of assets do you use to achieve this kind of diversification? Let’s start with fixed income.
Brown: The Income Fund is designed to suit investors that may be making their first steps away from term deposits, or those of us that may not sleep well in volatile times.
Within fixed income, we have regular investment grade bonds, which are well understood and have a high “sleep well at night” quality about them. New Zealand bonds issued by the “gentailers” and listed property companies offer relatively attractive yields. And beyond these, options can also include small holdings of high yield corporates and private credit deals, where funds invest directly with companies on the same terms that banks receive. As long as you implement stringent credit research and risk management, there is potential to earn a premium in this space, as there is less capital contesting for returns in this segment. Examples we have invested in include funding for a portfolio of wind farms in Australia, and a data centre owner/operator.
Murphy: And what about equities?
Brown: In equities, there is a range of characteristics you can focus on, ranging from stable dividend-payers, to the growth companies that are thriving as we adjust to the impact of technological change and Covid-19. These choices are available both domestically and globally. Again, diversification is a key focus to get the returns available from equities, while managing the increased risk profile that they can bring.
Murphy: What process do you use to juggle these different asset classes when you are constructing a portfolio?
Brown: The job is made simpler because of the extremely experienced team around me, covering each of the different asset classes and providing research and modelling which influences the decisions that go into managing the Income Fund. We also engage offshore fund managers to invest in a broad range of global credit and equities.
Each manager has their specialties, so we seek complementary and uncorrelated characteristics. My role is to manage the fund; to bring everyone’s knowledge and expertise together with a strong eye on risk management, and figure out how to utilise this information to perform for clients.
For any investor, diversification and awareness of your own risk appetite are key factors that can enable the move away from term deposits, and create a credible plan for improving investment returns.
This does not constitute advice to any person. www.harbourasset.co.nz/disclaimer
If you would like more information on the Income Fund, or any other Harbour Fund, please contact:
Shannon Murphy, Investment Specialist Shannon.murphy@harbourasset.co.nz (09) 365 1925
