Step out of the shadows

With interest rates at almost all-time lows it is difficult for savers and retirees alike to generate reasonable returns on their money.

As a result, investors are tempted to look further afield than the usual term deposits or low risk bonds for their fixed interest returns and their appetite for high yield investments remains despite a growing list of corporate and product failures.

A number of these failures have come from unlisted, unrated debenture providers (Shadow banks) Banksia, Gippsland Secured Investments, Australian Secured Investments Limited, Wickham Securities, FinCorp, Westpoint, the Cherry Fund and Cymbis Finance (just to name a few).

What is a shadow bank?

Shadow banks are financial institutions that provide credit and perform other bank-like functions, but are not regulated and licensed as banks.

They generally act as intermediaries between investors and borrowers and don’t receive traditional deposits like a depository bank (CBA, ANZ)

Shadow banks often offer investors high interest rates on debentures and then lend these funds out as mortgages or property loans. These debentures are usually marketed as ‘bank like’ investments.

Why are they more risky than traditional banks?

Shadow banks are unregulated, which means they are able to take on higher market, credit and liquidity risks, without the same capital requirements and risk controls as regulated banks. While that can allow them to offer attractive rates to both borrowers and lenders, it also has the potential to give rise to systemic risks.

Shadow banks supply loans which might well not be offered by a registered bank. Often these loans are made to commercial property developers and, in return for a relatively high rate of interest, there is usually a much higher chance of default.

What can I do to protect my interests?

  • Be careful about debentures generally.
  • Do not be swayed by the promise of higher returns – many investments that promised higher interest have run into trouble.
  • Actively manage your interest rate risk exposure. This can be done by ensuring you have more ‘floating’ rate investments (i.e. those whose income payments move up and down with interest rates) where interest rates are expected to rise, and using ‘fixed’ rate notes (i.e. whose income payments are fixed for the term of the investment), where interest rates are expected to fall.
  • Building an income oriented portfolio is not about simply investing in term deposits as these alone will not help you boost your income.
  • Fixed income is a very broad market; consider a diversified approach involving high quality bonds which can help provide stability and smooth portfolio returns in times of high equity market volatility.
  • Consider a mix of semi government and high quality corporate debt, allowing access to higher rates of income with relatively little added risk.
  • For those comfortable with an increase in risk, high yielding Australian shares are worth considering. Dividend yields are attractive and they also provide scope for capital growth over time.

Securing a high and stable income stream is difficult in our current low growth, low interest rate environment so it is worth considering a diversified approach.

Remember if it sounds too good to be true it usually is!

 

Knight Financial Advisors Pty Ltd is a Corporate Authorised Representative of NKH Knight Holdings Pty Ltd (AFSL 438 631) ABN 30 163 152 967. The information contained herein is of a general nature only and does not constitute personal advice. You should not act on any recommendation without considering your personal needs, circumstances and objectives. We recommend you obtain professional financial advice specific to your circumstances.

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