How the RBA’s 0.25% target impacts term deposit profit
Term Deposits (TDs) are a well-known way of getting reliable income, but nowadays they provide little to no income. Since the RBA dropped the interest rates in response to CV-19, making money from Term Deposits seems like the start of a bad finance joke. However, this artificial ‘peg’ creates opportunity for astute investors to capitalise on the Government’s artificial participation in the fixed income markets.
Term Deposits are a bad investment
We have previously looked at why TDs are a bad investment for most people. Click here to see the video discussion on why. .
The 3-year Peg
On March 19 this year, to ensure that there is enough money for banks, borrowers, businesses and the rest of the economy, the RBA started trading in the fixed income markets with the mandate of a 0.25% target for 3-year bond rates.
What this means is that the banks have access to cheap money for at least three years. The RBA will make sure any bank wanting to access the money can get it at 0.25%, regardless of what happens to the AUD or share market, here or abroad.
Fighting with two arms tied behind their back
The fixed income markets are competitive, arguably more competitive than the share market, and not a place for the inexperienced trader.
The RBA is effectively fighting with two arms tied behind their back when trading in the fixed income markets with the mandate of a 0.25% target for the 3-year bond rates. While this will cost the RBA (Australian public) a lot of money, it’s the best possible way they can promote growth in the current CV-19 economic climate of .
Who is Making Money here?
There is a lot of variance between the rates TDs pay, so whether we’re looking to invest $5000 or $500,000, it pays to shop around and find the bank with the best rates.
Similarly, there are professional fund managers whose full-time job it is to do shop around for TD rate all day, every day, for millions and billions of dollars. Sometimes their clients are governments, large superannuation funds or other large institutions. Other times their clients are everyday people like you and me, through a managed fund.
Why ETFs are also Handicapped
With the RBA fighting with no arms, the active investor, or fund manager, can easily move their way around the RBA to get the best punches in and help their clients get better performance.
On the other hand, Exchange Traded Funds (ETFs) have fixed rules known as mandates, re how they invest other people’s money. These mandates will stipulate that a certain percentage of the money must be invested in, say, 3-year bonds.
As we know, 3-year bonds are not providing any reasonable return for some time to come now, so the ETF will be stuck holding dud investments because the mandate dictates that they must, but the active fund can choose not to hold onto these duds.
How the Astute Make Money:
Active investors have noted two key aspects in this CV019 market:
1) Inflation is set to rise.
In living memory, we have never seen this much money printed and at the same time this much fiscal stimulus (Job Keeper etc).
Every economics textbook states that these actions mean that inflation must go up. Exactly when is the question, but early indicators already show that inflation is on the rise.
Active fund managers in this space have bought inflation-linked bonds, effectively term deposits, with inflation protection that makes your return go up when inflation goes up.
2) The Good, the Bad and the Ugly impacts of CV-19
Not all parts of the economy are impacted the same way by CV-19. Active managers look at the worst hit (tourism, hospitality, education etc.) and avoid investing in those troubled areas. ETFs are stuck with the percentage mix their mandate dictates, which can mean holding onto bonds to Virgin Airlines etc.
Couple these strategies with the RBA’s 3-year peg, and you can see why our favour is for an active manager in the fixed income space during the CV-19 climate.