Numbers In Safety

Sydney Morning Herald

Wednesday August 7, 2002

Michelle Innis

There are better ways of investing conservatively than burying your cash in the garden, reports Michelle Innis.

There are times when it makes sense to settle for modest returns purely for the sake of security. There's no such thing as a sure thing but investing at the conservative end of the market will almost certainly deliver your money back.

If you've been burnt by the sharemarket slide or you need to stash some cash in an at-call account and want to be sure your capital is safe, there are a few low-risk options for investing.

Independent investment consultant Dominic McCormick says few investors can afford to ride out a sharemarket downturn fully invested or fully geared.

He says cash management trusts, term deposits and other cash-type investments should form part of a balanced portfolio but warns investors not to be too reactive.

``Having some defensive assets makes sense," he says. ``But I would not encourage people to move [entirely] to cash for the sake of it right now."

Selling poorly performing shares will crystallise losses. And it may be too early to lock into a term deposit as most economists believe interest rates are on the way up.

Economist Annette Beacher, from Salomon Smith Barney-Citibank says: ``The housing market is still strong and retail sales continue to move at a good clip. The next move for rates is up. If you are going to lock in, make sure you can roll over your investment and access higher rates when they come."

REGULATORS' ROLE

The easiest and safest investment is a term deposit with a bank. Australian banks do not offer deposit insurance (as is the case in the United States) but the industry regulator, the Australian Prudential Regulation Authority (APRA), says no Australian investor has lost money deposited into a bank account since the 1920s.

``There are no guarantees," says Keith Chapman, APRA's diversified institutions division general manager. ``The certainty that your money will be returned is supported by the bank's balance sheet, not APRA or the government."

In other words, if a bank goes bust, the government will not refund your money. ``But the way the regime is structured, the system is robust."

APRA is responsible for regulating ``approved deposit-taking" institutions, such as banks, which are also governed by the Banking Act. Managed funds come under the auspices of the Australian Securities and Investments Commission (ASIC).

Both regulators will have an eye on an institution that has both a banking licence and managed fund products.

Chapman says APRA has strong ``transfer of engagement powers", which means it can force a bank that is about to go bust to merge with another bank to ensure no losses. The Commonwealth Bank took over the State Bank of Victoria this way in the 1980s.

AS SAFE AS THE INSTITUTIO

NAndrew Willink, managing director of financial services research firm Cannex, says term deposits require an element of trust. ``Your money is only as safe as the institution," he says. ``It is important to make sure you're comfortable with the institution. You can't be blase about your money."

Australian banks generally offer similar interest rates for similar terms.

Jason Hill, a banking analyst with ratings agency Standard and Poor's (S&P) says: ``A bank might step out of a rate band for a short period because it needs to raise funds that have a particular maturity. In Asian markets, you'll see very high interest rates as banks try to attract liquidity. But, generally, in Australia they sit together."

S&P and its competitor, Moody's Investors Service, provide credit ratings to banks and corporations that raise funds. They also rate investment products.

Banks use their credit rating when they raise cash in the professional money market. A bank with a AAA rating pays less for the funds it borrows than a bank with a lower BBB rating.

Retail investors can also use the rating to better understand some of the risk associated with an investment product or financial institution.

THE RATINGS SYSTEMS

S&P's Greg Barr, who rates managed fund products, says the top possible rating for a cash management trust (CMT) is AAAm, where the m denotes a money fund. This rating means the fund is extremely likely to meet its obligations to redeem investors' unit holdings at par or face value.

A fund rated CCC ``exhibits an extremely vulnerable capacity" to meet its obligations and a fund that has slipped into a D rating has failed to return investors' funds. Moody's has a similar rating system although its rating methodology may be slightly different.

The rating agencies frequently work on site with fund managers and other financial institutions to ensure their systems are robust, the funds are invested in the way they should be and managers have strong compliance systems in place.

THE PRODUCTS

CMTs provide more flexibility than term deposits, generally because within 24 hours, or sometimes less, you can access your cash. Some also come with a chequebook. (See ``Safer than houses" panel opposite.)

Term-certain annuities, which guarantee both returns and capital, are also low risk. Term-certain annuities sit within a life company structure and features of the annuity such as term, when interest is paid and return of capital are determined by the investor. Super and non-super money can be invested in a term-certain annuity.

MLC's term-certain annuity, known as a MasterKey Annuity, pays about 5.8 per cent for a five-year term. MLC's S&P rating is AA.

Zurich, which has a slightly higher rate of return at about 6.4 per cent over five years, is rated A+.

Sam Sorace, a regional manager with Zurich Financial Services, says term-certain annuities invest in a range of underlying assets to ensure the income can be generated and the capital returned.

``There would not be a case where we would not return the funds," he says. He adds the risk for investors lies with the provider. ``You need to be sure that the manager will be there when the annuity contract expires," he says.

GOVERNMENT BONDS

Government or semi-government bonds are considered a secure investment. State and Federal governments issue bonds to raise money to fund their obligations. Retail investors can buy bonds in what is known as the secondary market.

An active secondary market means bond holders can trade their securities rather than wait until they mature to get their cash back.

Tony Lewis, a fixed-interest specialist with Lewis Securities, has been trading bonds in the secondary market since 1978. Lewis Securities runs a Web site (www.fixedinterest.com.au) that quotes live buy and sell prices in the same way as the Australian Stock Exchange quotes share prices.

Bonds, which pay a fixed rate of interest, mature on a fixed date. They carry the investment risk of the issuer. A Federal Government bond, which is guaranteed by the Federal Government, would generally have a higher credit rating than a bond issued by a company known as a debenture.

But many factors, including the current state of the economy and a change in interest rates, can affect the price of bonds. ``The objective is to maximise the interest rate you get," Lewis says. ``However, interest rates are generally higher for lower-quality, longer-term and less-marketable securities."

DEBENTURES

Lewis also trades debentures. Companies issue them to raise capital and interest may be paid annually, half-yearly, quarterly, monthly or it may be compounding.

Debentures can be asset-backed and the purchaser of the debenture can make a direct claim on those assets, which might be car loans or mortgages if the issuer defaults. There is a higher risk associated with debentures than with government bonds.

``Is the company you're lending money to as good as you think?" says Willink. ``And if the debenture is structured in such a way that you don't get regular interest payments, how else will the company keep in contact with you?

``Interest payments often represent a form of correspondence or a contact point. Regular payments let you know that the company is alive and breathing. If there is no communication over, say, a year, how are you to know that everything is OK?"

Willink warns investors who buy debentures that pay interest at maturity may be hit with an unexpected tax bill. ``That's a double whammy," he says. ``You get taxed on the implied interest each year but you don't get the use of the interest payments through the life of the investment."

Zurich's Sorace says term deposits that generate more than $1000 a year in interest can leave investors with a provisional tax bill. This is tax that has to be paid in advance. Term-certain annuities pay tax as you go.

TRADE-OFF

As with all investments, the key is balancing the rate of return against the risk, says Willink.

``Make sure the interest rate is not too far away from a money market rate," he says.

``If you are buying a debenture with a long life, check the interest rate against the rate offered on a government bond with the same maturity.

``If the rate is much higher then it implies much higher risk."

Safer than houses

Generally, savings accounts and term deposits with major financial institutions are the safest places for your money.

Cash management accounts with banks are known in industry jargon as ``on-balance sheet", which means the money raised is lent out to the institution's customers. Often this means the deposits end up as mortgages.

For those wanting a higher rate of return and 24-hour at-call access, the cash management trust (CMT) has become the most popular parking place.

The CMT is an ``off-balance sheet" unit trust, which means it usually invests in investments unrelated to the institution, such as government bonds, bank bills and some exposure to mortgages. As a unit trust, it will have a prospectus, which will spell out how it invests.

Investing in mortgages, depending on the quality of borrowers, can be a big step up the risk scale from the likes of government bonds and bank bills. Mortgage-style investments that have failed usually have an insufficient spread of borrowers.

Tim Farrelly, an executive director with Macquarie Bank, says investors like to put their investments into ``risk baskets".

``For cash they tend to want the most secure investment vehicle of all and then they are happy to have their shares in the highest risk basket," says Farrelly.

Maquarie Bank's $8.7 billion cash management trust is the largest in Australia and has the highest rating from the international credit ratings agency Standards & Poor's, AAA.

Farrelly says if his CMT invested in mortgages, even partly, it would not earn a AAA rating.

Some smaller banks' CMTs invest wholly in their own mortgages, which allows them to pay slightly higher rates, but they are not necessarily riskier.

Another type of deposit-taking account, the online savings account, is attracting money away from CMTs as it can pay up to 1 percentage point more than most CMTs. The biggest, ING Direct's Savings Maximiser, pays 4.75 per cent.

ING Direct's head of direct banking, Craig Kennedy, says it can pay more because costs are kept down by online distribution and the fact it's a ``vanilla" savings account credit cards or cheque books cannot be connected to it.

AMP, HSBC and St George have followed ING and have similar products. These are deposit-taking accounts, not unit trusts, and it is the credit rating of the institution that matters. ING's Savings Maximiser invests almost wholly in mortgages. JC

See Snapshot page 3.

                Year of maturity
 Bonds  2004    2005    2007-2012*

 AAA NSW Tr. Bonds      NA      5.16    5.67
 AAA Qld Tr. Corp       5.62    5.78     NA
 AA+ SAFA Bonds 5.06    5.26     NA
 AA+ WA St Bonds        4.9      NA     5.47
 A- Qld Inv Bonds       5.3     5.55    5.65

 * Average

 SOURCE: CANNEX & S+P RATING

HIGHLY RATED CMTs - $50,000


Institution                             Rating  Interest
                                                rate %
AMP CMT                         AAAm    3.76
AXA Australia CMT                               AAAm    3.97
BT CMT                                  AAAM    3.92
Colonial First State CMT                        AAAm    3.50
Colonial First State Premier CMT                AAAm    3.98
INVESCO Wholesale CMT                   AAAm    3.88
JB Were Cash Trust                      AAAm    3.96
Macquarie CMT                           AAAm    3.68
Merrill Lynch CMT                               AAAm    3.79
MLC Masterkey CMT                       AAAm    3.71
Nat Aust Trustees At Call Common Fund A1        AAAm    3.85
Ord Minnett CMT                         AAAm    3.69
Perpetual Cash Management Fund          AAAm    3.86
UBS Warburg CMT                         AAAm    3.81
Tower Trust Cash Deposit Fund           AAAm    3.90
Commonwealth Prem Cash Man Fund         AAAm    3.78
HSBC Australian High Yield Trust                Am      4.59
HSBC Australian Money Market Trust              AAAm    4.28
Macquarie Treasury Fund                 AAAm    4.82


STANDARD & POOR'S RATING PROCESS FOR CMTs
Rating                  Min % of portfolio represented by highly liquid invest
AAAm                    50
AAm                     40
Am                      33
BBBm                    25


Evaluated by: Credit risk of assets, liquidity risk from the withdrawal of
investments in the fund, Interest rate or market value risk and fund management
capability

© 2002 Sydney Morning Herald

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