Is it time to switch out of TDs?

It may be time for investors to review their allocations to Term Deposits, according to Franklin Templeton global fixed income asset manager, Western Asset.

Pointing to a growing consensus that interest rates have peaked, Western Asset is claiming that now may be an opportune time for investors to reassess investment options and that a prime case in point ought to be Term Deposits versus actively managed bond funds.

“Taking the Australian Composite Bond Index, with a duration of approximately 5 years and a yield of around 4.55%, a straightforward calculation illustrates the superior return potential of a core bond portfolio versus TDs as yields decline,” Western Asset’s analysis said.

“For every year of duration, a parallel shift lower in the yield curve approximately equates to a 1% increase in capital prices. If yields were to decrease by 1%, a capital uplift of approximately 5% would occur. Similarly, a 0.5% decrease in yields would amount to an approximately 2.5% capital uplift on a 5-year duration portfolio.”

It said that when compared to an actively managed fixed income strategy, Western Asset notes that “a TD has a lower flexibility and liquidity; no upside potential if yields decline; has limited diversification and higher concentration risk; includes investment risk; cannot benefit from active management and poses administrative inefficiency.”

“In sum, the benefits accrued to Term Depositors from the lack of capital movement during a period of steadily rising yields appear to have reached their peak. If economic growth stalls and yields move lower in expectation of rate cuts, fixed income portfolios will benefit whereas TDs will not.

“Seeking to defend margins and maintain profitability, ‘bonus’ rates on cash at call may also be subject to more onerous conditions in future and TD rates may be lower when the time comes to roll them, even if official rates stay constant.

“In that case, investors may be better rewarded investing in an actively managed portfolio of Australian cash and bonds, targeting similar levels of income with potential for capital uplift for the most defensive investors, who have low tolerance for interest rate volatility and drawdowns but wish to add some protection from reinvestment risk, the Western Asset Conservative Income Fund is an option.”