Risk-free investing days are coming to an end … here are some choices

The big issue for investors is not that rates were finally cut a quarter of a per cent this week, it’s the change of direction that matters – for the first time in four years, rates are going down, and that demands action.

At a stroke, the RBA rate cut suggests that a brief spell when investors could have money productively invested in cash is coming to a close. Government-guaranteed returns of 5 per cent are rapidly becoming a thing of the past.

And whatever your personal view might be, we have to take the banks seriously. NAB chief executive Andrew Irvine clearly believes rates will continue to drop from here. Speaking at the bank’s results presentation this week, he said: “I think [the cut] is going to have an outsized effect on confidence. Signalling that rates have peaked and now we are moving to a downward cycle is pretty huge.”

In fact, the major banks were cutting cash deposit rates before this week’s official rate reduction. Sally Tindall at the Canstar research group says: “There are still a handful of deposit products offering above 5 per cent, but they are disappearing fast.”

For now the best rates are more commonly 4.5 per cent-plus – but the thing is that underlying inflation remains at 3.2 per cent.

In other words, if the bank economists have it right and there are several more rate cuts to come, the game is over – cash will soon be a losing proposition.

Faced with “deposit rate decline”, there is nowhere for an investor to go other than “up the risk curve”.

Where to turn?

Traditionally, investors would tip-toe back towards bank shares or bank hybrids when rates were cut: Blue chip ASX stocks, including bank stocks, are still offering (grossed up – after franking) yields of more than 5 per cent. And even with a clouded outlook for those stocks – due to sky high valuations – they will remain popular, if less lucrative. Bank hybrids are being phased out by the regulators.

Meanwhile, mining stocks – the other potential big dividend payers in the local market – are now at the bottom of their cycle. Both BHP and Rio Tinto cut dividends sharply this week.

As miners and most banks struggle to provide a proxy for cash deposits, a likely avenue investors will turn towards for income is property offered in the form of listed property trusts or inside the newer option of private credit.

Property trusts – or A-REITs – have already been strong performers on the market over the last 12 months as the growing conviction that an interest rate-cutting cycle took hold. Over the past 12 months, the A-REIT index is up 13 per cent, while the wider ASX 200 is up 9 per cent.

This A-REIT sector is now in a sweet spot – for evidence, look no further than the market’s biggest property player, Goodman, which announced a $4bn raising this week that was snapped up by institutional investors within hours.

The other sector in a sweet spot is private credit. Falling interest rates offer this group the perfect conditions for marketing their message that they can offer rates “just as good” as the banks to private investors. Indeed, they will use awfully similar language, talking of “cash distribution yields paid monthly”.

SQM Research director Louis Christopher.

The problem is that such funds can be much higher risk than traditional bank products. They may also lack transparency, and some funds will find it difficult to give investors their money back promptly should their projects fail to any degree.

For income investors, the plain truth of a rate cutting cycle is that you may replace the returns you had, but if you managed to do so, you will take more risk – and your returns will not be guaranteed.

There is, of course, good news in a rate cut, and it applies most keenly to mortgage holders and property investors who have been waiting for months for a turn in the residential market – especially in Melbourne and Sydney, where prices have been falling during the summer months.

It’s hard to believe that a single rate cut, in itself, could change the fortunes of property investments in major cities, but property analysts Louis Christopher at SQM says: “The cut should do it, and if we get more than one cut it will certainly make a difference to property investment conditions.”

Christopher had made the bold prediction that without a rate cut Melbourne and Sydney were heading for a downturn in the year head. He had suggested Melbourne would see a 3 per cent drop and Sydney a 4 per cent decline.

The rate cut upended this scenario – now he forecasts Melbourne will gain 2 per cent in the year ahead, Sydney will gain 3 per cent, while other regional capitals will continue to surge higher – with Brisbane and Adelaide looking at 10 per cent-plus and Perth expected to move 15 per cent higher.

It looks like many investment leaders are expecting an awful lot from a very small rate cut – but the only thing we know for sure is that from now on any money on deposit is going to pay less.

James Kirby presents the twice-weekly Money Puzzle podcast.

This article first appeared in The Australian.