Investing in low interest-rate environment
Where to put your money for better returns when rates are getting lower?
INTEREST rates affect consumers and businesses in many ways.
From determining the return they earn from their savings accounts and investments to the cost of taking out a loan – be it for a home, a new car or any other purchases or investments – households and companies will have to decide what to do with their money when interest rates change to make it work for them and achieve their ultimate goals.
Importantly, this is to ensure one’s money and assets do not lose their value or buying power through inflation over time.
As it stands, central banks around the world have been slashing interest rates – some aggressively so – in recent months in an effort to boost growth, and to contain the impact of a slowing global economy.
In Asia, among the countries that have seen their central banks cut interest rates or eased their monetary policies since entering the second half of 2019 are China, Hong Kong, Japan, South Korea, Indonesia, Thailand and the Philippines.
Another rate cut?
Interestingly, Bank Negara was the first central bank in South-east Asia to cut interest rate this year when it lowered the overnight policy rate (OPR) by 25 basis points (bps) to 3% on May 7 amid concerns of a potential slowdown in the country’s economic growth.
Expectations are rising that Bank Negara will cut its key interest rate again next month.
According to a poll of 24 economists by Bloomberg, 17 expect the central bank to slash the OPR by another 25bps to 2.75% before year-end, while seven expect the central bank to keep the benchmark rate unchanged through the year.
Of the seven that expect the OPR to be held at 3% through 2019, however, three expect Bank Negara to cut the OPR in the first quarter of 2020 by 25bps to 2.75%.
Bank Negara’s Monetary Policy Committee (MPC), which sets policy rates, is scheduled to meet on Nov 4-5.
After that, the MPC, which is required by law to meet six times a year, is expected to convene again in mid-january 2020.
In its recently released projection, the government expects Malaysia’s gross domestic product (GDP) to expand 4.8% in 2020, which some economists contend as being “too optimistic” in view of the increasingly challenging external environment.
As with any small and open economy, they explain, Malaysia will not be immune to the challenges in the global economic environment. So, they expect Malaysia’s GDP to grow slower in 2020, or at best, expand at the same pace as in 2019.
According to official projection, Malaysia’s GDP is expected to grow 4.7% this year.
In general, central banks cut interest rates to encourage consumers and businesses to borrow money and spend or invest it in order to boost their countries’ economy.
Lower borrowing costs
When central bank adjusts its key benchmark interest rate, commercial banks will follow suit with a corresponding adjustment in their lending rates as well as deposit rates.
For instance, when Bank Negara cut the OPR by 25bps in May, most commercial banks in the country also began to lower their lending and deposit rates by around 20bps to 26bps.
Excellentte Consultancy Sdn Bhd financial planner Jeremy Tan notes businesses and individuals will feel the positive impact from lower borrowing costs.
“For businesses that depend on capital to fund their business, lower borrowing costs will increase profitability, and it also give companies the ability to grow and expand their business with the availability of funds at lower cost,” he says.
As for individuals, the cost of borrowing to buy a new home, for instance, will be lower. This, Tan points out, improves affordability for first-home buyers, which in turn, could boost the property market.
For existing borrowers, monthly repayment for certain loans would likely be reduced if commercial banks adjust their rates accordingly. This, in turn, means more disposable income for the consumers.
In such instances, however, Tan recommends consumers to maintain the payment at the original amount to reap the benefits of paying off the loan earlier than it is due.
“In lower interest rate regime, there is always a tendency of consumers taking advantage of the lower financing cost to acquire new assets. However, it is advisable to focus more on appreciative assets such as properties in a good location, rather than depreciative assets such as cars and luxuries,” he says.
Meanwhile, Stashaway Malaysia Sdn Bhd country manager Wong
Wai Ken argues that while interest rate cuts would mean cheaper loans for those seeking to fund assets, one should be cautious when considering taking out a loan to acquire new assets, especially in the property market.
“Before committing to a mortgage for an investment property, ensure that you have at least three to six months in cash for personal emergencies, and a further few months in cash reserves to absorb the interest payments in case a tenant for the property is hard to come by,” he explains.
For existing borrowers, if one already has a fixed-rate loan, restructuring the loan after rates adjust downward is a good idea, as this would result in significant interest savings, Wong says.
“If one is on a variable-rate loan, the reduction in interest payments should come as a small relief,” he says.
“In these cases, remember that while saving is good, investing is better, so put those interest savings to work,” he adds.
Wong gives a simple example: For an annual savings of RM1,000, one would have slightly more than RM20,000 by the end of 20 years. But if the same amount is invested in an instrument with an average annual return of 6%, one could see the money grow to more than RM42,000 by the end of 20 years.
Small return on deposits
The whole point about investing is to grow the value of one’s savings to ensure the money that one has today can buy a lot more things in the future than it does today.
The movement of interest rates matters, as they have an impact on the future value of most investments.
In the case of putting money in a savings account or fixed deposit (FD), return will inevitably be lower when there is a cut in the key benchmark interest rates.
According to financial experts, while lower interest rates on savings accounts or FDS make these products unattractive, one should not switch out of conventional savings products entirely. They note it is advisable for consumers to keep a portion of their money in these liquid assets before allocating their resources on other investment products for emergency purposes.
Wong, for one, notes it is ideal to keep between three and six months’ worth of living expenses in cash and FD.
“Retaining three to six months’ worth of living expenses for personal emergencies is always a good idea regardless of the interest rates, as you never know when you will need to access these funds,” Wong explains.
Tan, on the other hand, argues, savings, particularly in the form of FD, is an asset class that can also serve as a diversifier for one’s overall investment portfolio.
After taking care of emergency funds, how much more money one should keep in savings accounts and FDS, according to Tan, will have to be based one’s desired rate of return on one’s total portfolio of investment assets (be it stocks, bonds, mutual funds or properties) according to one’s goals or objectives.
“A total review of each of these asset classes in tandem with the current interest rate regime will determine if the adjustment is appropriate and relevant to one’s portfolio,” he says.
Tan opines that for individuals with low risk appetite, investment options are rather few and limited.
“Other than FDS, other options available will be a portfolio that includes fixed-income instruments such as bonds, fixed-income securities, bond funds and blue chips stocks/shares with a good yearly dividend payment track record,” he argues.
M oney market funds
For conservative investors looking for yield, Wong points out, a money market fund could be a good option, as it gives investors a return that is close to FD rates, but without the need to lock up one’s money for a fixed period of six to 12 months.
“Money market funds are highly underrated as there is little to no sales commissions on these funds, and unit trust consultants are not incentivised to market them,” Wong argues.
“However, the benefits are clear, as this investment is very liquid and low risk with the underlying investments being FDS and shortterm corporate and government debt securities. Corporates have been taking advantage of money market funds for years to ensure their idle cash is earning an investment, and individual investors should follow suit,” he explains.
Wong, however, points out keeping more than six months’ worth of living expenses in cash, FD or money market funds when interest rates are trending down, could risk investors’ net worth being eroded by inflation.
This is especially in a negative interest rate environment, that is, when inflation exceeds the nominal interest rate.
To counter that, Wong notes, there are protective assets that could yield more than FDS such as bonds, real estate investment trusts (Reits) and dividend-yielding blue chips, which could give higher return for slightly higher risk.
“When it comes to investing, we are proponents of diversifying one’s investments across different asset classes such as stocks, bonds and gold. This allows one’s portfolio to better withstand economic, political and interest rate risks,” he says.
“Having portfolios that are less volatile and are protected in volatile markets allows investors to focus on the long term and stay invested,” he adds.
Impact on bonds
When it comes to bonds, an inverse relationship is observed between interest rates and the asset price. All things being equal, when interest rates fall, bond prices rise. When rates rise, bond prices fall.
Nevertheless, bonds usually offer yields that are higher than most fixed-deposit options in domestic banks, even after taking inflation into account.
“Should interest rates fall, bond prices would rise, as investors looking for yield would pay a premium for bonds,” Wong says.
He adds investors could also turn to corporate bonds, which usually yield higher return, compared to government bonds that are almost risk free.
“For most retail investors who don’t hold bonds, an easy way to begin is to buy a bond exchange traded funds (ETF), which holds government or investment grade bonds. Bonds play a very important role in any portfolio, as it is less risky compared to equities. So, they act as portfolio insurance by reducing the swings in one’s portfolio,” Wong explains.
In the past, for non-institutional investors, only high net worth, sophisticated individual investors can afford to invest in bonds, as standard lots for corporate and government bonds were traded at Rm5mil and Rm10mil, respectively.
Retail investors now have greater access to Malaysia’s bond and sukuk market after the Securities Commission liberalised the regulatory framework for asset class in September last year.
Under the new bond seasoning framework, retail investors can access corporate bonds and sukuk on over-the-counter market from as low as RM1,000.
With the liberalisation, analysts expect Malaysia to see an increasing shift of retail investors from FD to bonds over the next 10 years.
Mixed on equities
According to Wong, falling interest rates typically bode well for equity markets, as businesses can now borrow more cheaply to fund their expansion plans, and consumers, who now have less incentive to save, will spend more.
“Whether one uses ETFS to replicate certain indices or directly hold a basket of stocks, one should still diversify across sectors, and (if possible) geographies,” he argues.
According to analysts, an OPR cut is positive on stocks in the consumer, property, construction and automobile sectors, as well as Reits.
“A lower OPR tends to boost disposable income and lift private consumption. And lower borrowing costs could boost an individual’s ability to purchase properties and automobiles, and help construction players to save n project costs,” an analyst with a local brokerage explains.
“As for Reits, lower OPR implies a downtrend in the 10-year Malaysian Government Securities’ (MGS) yield. This helps maintain the yield spread between Reits and the MGS,” he adds.
Furthermore, Reits could see a drop in the interest cost for their borrowings. This enhances their profitability, the analyst says.
Conversely, a cut in the OPR is expected to have a negative impact on banking stocks, as banks could see their net interest margins - the difference between the interest income generated by banks and the interest paid out to depositors – narrow further, and could see earnings come under increasing downward pressure.
Glittering gold
If one were to listen to investment guru Mark Mobius, one would love gold.
A gold bull, the founding partner of Mobius Capital Partners, recently told CNBC in an interview that “physical gold is the way to go” as central banks around the world cut interest rates.
He recommends investors hold 10% of their portfolios in physical gold, and invest the rest in dividend-yielding equities, in order to maximise return in a low-interest rate environment.
Mobius points out that the “incredible increase in money supply”, in large part as a result of central banks’ actions, could lead to all currencies losing their value in the future.
And herein lies the importance of gold, which is a proven store of value and an insurance against inflation throughout history.
Traditionally, gold is favoured for its “safe haven” attributes in times of economic uncertainties and market volatility.
For instance, the ongoing Us-china trade dispute, and weakening global growth prospects as well as the global trend of declining interest rates, have in recent months driven investors to seek refuge in gold, resulting in the rise of the previous metal.
In early September this year, spot gold prices soared to a sixyear high of US$1,552.55 an ounce following the escalation of the Us-china trade wars.
Prices of the precious metal have since eased to around US$1,490-US$1,495 an ounce over the week, which represents a year-to-date increase of about 16%.
According to Credit Suisse’s projection, gold prices could rise to US$1,600 through the first half of 2020, supported by global economic uncertainty and the low interest rate environment.
For the rest of the year, the Swiss bank expects gold prices to rise to US$1,550 an ounce.
UBS Group, on the other hand, is even more bullish, projecting the prices of the yellow metal to reach as high as US$1,730 an ounce next year.
Still, there are investors who scoff at gold for their lack of income, noting the commodity does not pay interest or dividends.
Take legendary investor Warren Buffett, who sees gold as an unproductive asset and, therefore, a poor investment choice.
To some critics, gold is an emotional investment, with prices of the commodity often driven by fear.
Like it or not, at the end of the day, gold is still widely acknowledged as a store of wealth. Hence, one should not entirely dismiss it as an investment option.
As Stashaway’s Wong notes investing in gold helps investors hedge against inflation and safeguard their assets in case a crisis occurs.
“Rising or falling interest rates do not have a direct relationship to gold, and it is for this reason investors should hold some gold in their portfolios,” he argues.
“By diversifying one’s portfolio through holding different asset classes, one reduces the overall risk that one is taking,” he adds.
Ultimately, the key to successful investing is to create a diversified investment portfolio, comprising several asset classes, that reflects one’s appetite for risk. This will require one to rebalance one’s investment portfolio every now and then to preserve value.