Duncan Hughes says yield-hungry investors need to check carefully the special offers they take up for strict conditions, get-out clauses and high-risk strategies.
Photo: Matt Jeacock
Desperate savers trying to squeeze more income from their capital need to be aware that many new offers from banks and fund managers come with strict conditions, get-out clauses and high-risk strategies.
Even zero-risk “bonus” and “special offer” savings accounts that promise another few basis points are loaded with small print conditions that exempt the higher rate.
Savers’ dilemmas are creating opportunities for fund managers to launch products offering much higher returns, which, for investors aware of all the potential risks, could be worth a look.
Top savings rates are typically about 3 per cent but come with strict conditions.
Saving and investment returns higher than the Australian Government 10-year bond yield of 1.97 per cent come with increased risk, say finance specialists.
Many products aimed at retirees and others seeking higher yields prominently advertise a much higher return, typically on the internet or targeting investors via email.
“Advertisements with explicit interest rates like a bank account create the impression of a fixed-interest product,” says Paul Moran, Principal Financial Planner with Moran Partners.
“People tend to think of fixed interest as safe.”
“But as rates rise, risk rises exponentially.”
For example, IPO Wealth, an authorised fund manager, is emailing offers of 6.45 per cent over 12 months.
Minimum investment is $100,000 and distributions are made monthly, or at the end of the term.
Its website offers 6.45 per cent over 60 months for wholesale investors, typically with a minimum investment of $500,000.
The company claims to be a “hassle-free alternative to bank term deposits, investment property and stock market investments”.
But small print conditions warn target returns are “maximum returns only” and not guaranteed.
It adds that an investment with the company is not a bank deposit “and subject to greater risk than cash investments” including “loss of income and part or all of the income”.
Investments include higher-risk small companies in emerging markets.
The company’s literature explains potential investment and liquidity issues (that is, getting access to your cash).
A spokesman says 88 per cent of investments are held in established markets, including the US, the UK, Australia, Italy and Switzerland.
He adds that the fund is not leveraged, which lowers risk.
Chris Brycki, Chief Executive and founder of Stockspot, an online investment adviser, says: “Any return needs to be looked at relative to risk.”
“It’s very hard to understand the level of risk with this product.”
“But investors need to consider whether the ‘target’ returns compensate the higher risk.”
Other companies such as Intus Life, based in Tallinn in Estonia, are offering Australian savers 7.5 per cent.
The company targets high-net-worth individuals around the globe.
Intus Life, which is regulated from St John’s in Antigua, uses France-based brokers who offer “a savings plan based on our investment fund via a savings plan [sic]”.
But according to the Australian Securities and Investments Commission (ASIC), the nation’s chief securities watchdog, Intus Life is not authorised to offer advice or products in Australia.
Those considering this type of scheme are strongly advised by the regulator to review any investment and currency risk.
The bad news is that local savings rates are more likely to fall than rise, as the Reserve Bank of Australia is expected to cut cash rates and banks are needing reserves to repair their balance sheets.
“You have to have your wits about you when doing research for the best rates,” warns Sally Tindall, a director of RateCity.com.au, which monitors rates and fees.
There are conditional offers, which impose certain conditions on the saver, and introductory rates, which are higher for a short period of time before reverting to a base, average, rate.
“A lot of savers can’t keep up doing the paperwork for a little bit of interest,” Tindall says.
“It is a tough market.”
“Top-paying” bonus rates, which can pay up to 2.9 per cent, come with strict terms and conditions, which, if breached, will result in returns sliding back to below 1 per cent.
In some cases, the bonus expires after an introductory rate, typically after three to four months.
For example, Newcastle Permanent recently dropped its online saver base rate by 0.25 of a percentage point from 1.10 per cent to 0.85 per cent.
But it launched a three-month promotion that increased rates by 0.25 of a percentage point to 1.95 per cent.
At the end of the term, rates revert to the base rate of 0.85 per cent.
Another popular income option is a high-yield “dividend harvester” fund, particularly for retirees who don’t mind trimming some of their capital each year.
The Australian market has a dividend yield of 4.3 per cent, compared with the average developed market dividend yield of 2.5–2.6 per cent, according to the Australian Stock Exchange.
Popular bank shares are paying a dividend of about 6 per cent.
Dividend funds hold companies such as Westpac and Telstra for the dividend payment period.
Then they are rotated into another collection of high-gross-yielding shares to collect the dividend payment.
Critics claim the problem is small share price drops after shares go ex-dividend.
In addition, the capital value of bank shares has fallen between 20 per cent and 30 per cent over the past couple of years.
That means a $100,000 investment in a term deposit that was moved into bank shares a couple of years ago is probably now worth about $80,000.
“What you get on one side you lose on the other,” Brycki says.
But Moran says they are a core holding for investors wanting income from their portfolios.
“There are a number of strategies available,” he says.
“In general, they provide less volatile access to share-like returns.”
“There are also strategies available to provide downside protection against significant sharemarket falls.”
* Duncan Hughes writes on real estate for The Australian Financial Review. He tweets at @duhughes.
This article first appeared at www.afr.com.
