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Low interest rates likely to be a problem for some time

Advisers and clients will need a mindset shift to deal with many more years of low interest rates, it has been predicted.

Thursday, June 16th 2016, 6:00AM 11 Comments

by Susan Edmunds

PwC has released a new report, examining the future direction of interest rates.

It says there is a 75% probability that the 10-year swap rate will be at 4% or below for the next two to five years.

Financial adviser Martin Hawes said that meant some advisers would have to change their investment strategies, particularly for clients who were worried about income.

“We need to move instead to think about total returns. A return which is a capital gain, which you can expect over long periods of time, is not quite as good but is valuable as well. You can access that to buy the groceries by selling units or shares.”

He said some clients could shortchange themselves by "scrambling around the place" looking for the highest interest rate they could find or the best dividend yield.

“If you say we won’t buy this Ryman share because it has a 2% dividend yield but instead buy something else with 7%, that’s the wrong way to think about it. Just because most of the return is in capital gains should not mean you don’t invest in it. The total returns should be about the same. 

“It’s a mindset change for clients who are looking to use their investment portfolio to get the necessities to be able to live. They immediately think of income, how can I do better than the 3% I can get from the bank and thrash around and might end up taking more risk.”

He said some investors were foregoing international investment exposure because they could get better dividend yields in New Zealand.

Jeff Stangl, of Massey University, said the biggest problem for advisers was making sure clients remained in appropriate investments for their circumstances.

"Advisers need to be aware if they are moving their investors out of their stated risk profile into different asset categories. That's a real issue."

He said it was something that was becoming a big problem as people who had budgeted a set amount for retirement realised they were not going to get the interest rates they expected.

Hawes agreed it was also important to maintain asset allocations and not be enticed by past returns into becoming too overweight in a particular asset class. “It’s very tempting to become more heavily weighted into equities but when you do that you have to realise you are taking more risk.”

Tags: interest rates investment

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Comments from our readers

On 16 June 2016 at 8:23 am Steven Popodopolus said:
A 75% likelihood means that there is a 1 in 4 chance of interest rates rising to emphasise Martins point about not becoming too overweight in certain asset classes.
On 16 June 2016 at 9:59 am R1 said:
The elephant hiding in this article is the fact that adviser fees eat up income and when interest rates/yields are low this becomes much more apparent to clients. If an advisor is putting their client's interests first this is an important part of the discussion too and how the adviser can reduce total fees without taking more risk is what many advisers need to consider.

By the way, selling growth comes at a significant cost too and needs to be factored into the total return calculation and disclosed.
On 16 June 2016 at 2:35 pm Brent Sheather said:
The other important issue here is that Martin Hawes, in his Sunday Star column, has consistently been of the view that interest rates were going to rise, telling readers that interest rates were much too low and not to buy long dated bonds.

That won’t have worked out so well for his clients but it does raise the possibility that given his previous efforts in forecasting interest rates and the current change of heart, that Mr Hawes may have just called the bottom of the interest rate cycle.
On 18 June 2016 at 4:10 pm henry Filth said:
"Just because most of the return is in capital gains should not mean you don’t invest in it. The total returns should be about the same. "

Now to access the capital gains you have to sell. Which means costs.

It also means that you are "selling your principal"

There are better ways. . .
On 20 June 2016 at 8:24 am smitty said:
@ Brent, yes that's the problem with being in the public eye isn't it (re Martin), you get pestered for a response on % rates, or the like, and you eventually relent, and give an opinion (not personalised I might add...). In saying that though, not far different from Advisers out there that advised to stay on the sidelines after the GFC as a precaution, "just hold fixed interest". Though that never seems to be reported...
On 20 June 2016 at 8:57 am Brent Sheather said:
Good comment from Jeff Stangle of Massey however that has been an issue for clients for all time. The standard wealth management model is moving client’s portfolios along the risk curve, frequently ignoring their risk profile, then appropriating most of the risk premium for themselves and the rest of the finance industry. For example the forward risk premium on equities, according to most non compromised experts, is 3% - 4% pa. Goodness me the average total fees, monitoring and management and turnover costs and platform costs etc etc are about 3% pa thereby delivering lucky clients the risk of equities with the return of bonds. Yes we know that some financial advisors are life coaches, walking client’s dogs, providing relationship counselling and speaking at their funerals but fees at that level still doesn’t really sound like putting client’s interest first does it? The fact of the matter is that the most insidious impact of high fees is that client’s risk profiles are frequently compromised.

Interested to hear from Good Returns readers if there is a mistake in that analysis!
On 20 June 2016 at 10:20 am Steven Popodopolus said:
I think that analysis of ongoing fees is outdated Brent, if that is indeed the average then I operate at half and know many many others doing the same. 0.3 platform, 0.35 management 0.6 advisor. Sometimes less.
On 20 June 2016 at 12:53 pm Brent Sheather said:
Thanks for that Steven. I certainly hope my numbers are outdated but I think not. Does your 35 basis point management fee include turnover costs both within the fund and within the portfolio? Unless you are using index funds I suspect not. I know that the FCA in the UK calculated that turnover costs can account for another 1% pa in annual costs and they calculated that using institutional brokerage rates and developed markets bid/offer spreads. As you know spreads are much higher in emerging markets. Therefore on your numbers 0.3 + 0.35 + 0.6 + 1.0 = 2.25%. Still a big hit on a 5% return from a balanced portfolio.
On 20 June 2016 at 5:17 pm gavin austin adviser business compliance said:
1% turnover costs - more like the adviser is churning the portfolio to drag more fees into his/her own pocket.

Also i believe brokerage costs in the UK are considerably higher that here so Brent why don't we use NZ data not some irrelevant market place on the other side of the world.

If an adviser was actively trading a portfolio to the extent you imply then the FMA should be having a very close look at why - oh and by the way turnover costs are only incurred when a broker is trading listed securities.

On 21 June 2016 at 8:59 am Brent Sheather said:
Hi Gavin Austin, Adviser Business Compliance

With due respect your comments suggest you don’t have a good grasp of the issues here. Having said that it is a very complex issue. The paper I refer to and indeed most others were written for institutional investors. There are three or four main costs involved in turnover including brokerage, which you have focused on, market impact and bid/offer spreads. Most papers on the subject calculate that the impact of spreads exceed the cost of brokerage by about 50%. A recent US study found that spreads average .47% of assets annually and commissions were about .3%. Gavin, note that these figures are per cent per annum not brokerage rates so they are calculated on the basis of turnover then expressed as a percentage of total assets.

As the papers were done for instos the figures just relate to trading within each fund by the fund manager and I am sure you know how high turnover can be as these are things AFA’s need to look at as part of putting client’s interests first. I am sure you also know the spreads are much wider for retail clients but market impact can be less. As I said these costs relate to turnover within each fund and to that must be added the cost of switching between funds.

To answer a few of your points:

• The 1% turnover cost doesn’t suggest the advisor is churning the portfolio as there is no advisor – it is the fund manager churning the portfolio.
• Brokerage costs for UK institutions are not higher, they are lower and the reason we quote offshore data is because NZ turnover data isn’t required by the FMA from fund managers and no its not irrelevant because as you know the average pension fund has 70% of its equity portfolio outside Australasia.
• Turnover costs in these papers are a decision made by the fund manager not the broker.

At my firm we don’t do the job properly but at least we are aware of the issues.

Hope this helps. Must say that there is a surprising lack of knowledge on this subject which is a worry considering all the valuable CPD everyone is apparently doing (LOL).

On 21 June 2016 at 11:43 am Steven Popodopolus said:
Thanks Brett, no, that is cost and a mix of index and active. I am sure there are costs to run the business, seems to perform pretty well against benchmark. I am not sure why you would simply make up a 2.25% fee.

It's a shame you are only achieving 5% gross for your clients when there is so much to offer out there doing better.

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