The Reserve Bank of Australia (RBA) lowered the cash rate in October this year to 0.75 per cent, its lowest level ever. The RBA see that the Australia’s economy not growing strongly enough and price inflation is currently weaker than its target of at least 2 per cent. By cutting the official cash rate the RBA is trying to stimulate the economy by encouraging banks to pass on lower rates to borrowers, who they hope will increase their spending, encouraging businesses to grow and employ more workers. However, the rate cuts don’t seem to be having the desired impact because the banks aren’t passing all the cuts through to all borrowers. In addition, banks have tightened their lending standards after the Royal Commission into misconduct in the banking, superannuation and financial services industry, and Australian households are already very indebted - owing almost twice the average annual household income.
What impacts do lower interest rates have on super investments? Since global interest rates reduced in response to the global financial crisis, lower rates and easy access to debt have generally boosted asset prices. In fact, a criticism of central bank interest rate policy has been that it’s been more effective in creating asset price bubbles than creating real economic growth. Many companies have increased their borrowings to repurchase their shares and pay dividends to shareholders and many investors have shunned low earnings from savings accounts, instead buying shares, property and other assets. This has increased the demand for those investments and lifted their valuations. Access to cheap debt and investors’ “fear of missing out” pushed markets like the US stock market to extremely high valuations, and residential house prices in Sydney and Melbourne (until recently) to record levels.
The impact on bond and other fixed interest investments is a little different. Bond valuations increase as interest rates fall – creating higher valuations of the bonds that you’re holding. However, for investors like super funds that need to keep buying more bonds as their pool of funds under management increases, lower interest rates mean that they will probably earn lower returns on the new bonds they buy.
As interest rates have fallen, infrastructure and commercial property investments have also become more attractive to investors compared to lower yielding cash and saving products. This is because the debt used to finance these assets has become cheaper to service while the income they produce has remained relatively stable. As a result, their valuations have also risen.
Cash investments which target an interest rate benchmark such as Rest’s Cash option, are likely to provide lower returns as official interest rates decrease. The lower return is a trade-off to the defensive benefits they can provide in comparison to higher risk asset classes like shares and property.
How is Rest positioned
With global economic growth slowing or negative in some countries and central banks already having used much of their rate-lowering ammunition, there’s now an increased risk that asset price growth may slow or reverse. This risk combined with trade war and geopolitical concerns and record high asset prices, has contributed to Rest positioning the Core Strategy to be relatively defensively positioned despite the lower interest rate environment. By holding a greater exposure to cash, and less in shares than many of our peers, the Core Strategy is better positioned for a downside correction and to take advantage of buying opportunities if and when asset prices correct. You can see the strategic asset allocation mix of the Core Strategy and other investment options by visiting the Investments section of our website.