Getting better returns in an environment of low interest rates

There are central banks around the world that are taking the unusual step of shifting interest rates to historic lows and even into negative territory.

The rationale is to encourage borrowing among consumers and businesses which will, in turn, kick-start spending and broader economic activity.

Many analysts expect interest rates to remain low for even longer, as a result of the uncertainties stemming from Brexit.

A low-interest-rate environment is good news for borrowers but it is typically frowned upon by depositors as their potential for returns diminishes.

In a "negative rate" scenario, a depositor would have to pay a financial institution to hold his cash. For example, if deposit rates were minus 1 per cent per annum, for every $1,000 deposited in an account, the depositor would have around $990 at the end of the year.


While currencies are unquestionably prone to fluctuations, investors tend to seek those with higher yields on offer as their values tends to appreciate in the short term. PHOTO: REUTERS

When seen through this lens, the cash depositor may feel he is in a no-win situation.

But it doesn't have to be this way.

While it may need investors to either try new investment types or shift their risk appetite, there are different asset classes that have the potential to bring about higher returns for investors than what they will get from deposits in this current environment.

FIXED INCOME

One example is retail bonds as bond prices and interest rates move in opposite directions.

If interest rates decrease, the price of a bond will increase because its stated fixed interest payments will be greater than those offered by the newly issued bonds in the market, making it more attractive to the investors. In other words, the bond sale price improves as interest rates decrease.

On the buy-side of this equation, investors who believe that interest rates will fall further may want to consider longer-tenure bonds in order to capitalise on a higher bond price - further down the lifespan of the bond - should this eventuality be realised.

The other advantage of bonds is that they offer investors the flexibility of choosing a bond that matches their risk appetite.

This is because each bond has a risk rating - which is based on the creditworthiness of the issuer - with government and investment- grade bonds being perceived as the most secure.

ASSETS WITH HIGHER RISK AND GROWTH POTENTIAL

Investors seeking even higher returns will inevitably need to cast their investment net wider to riskier assets.

Currency trading sits in this basket.

Even in a low-interest-rate environment, there will be a difference in yield for different currencies. While currencies are unquestionably prone to fluctuations, particularly in periods of economic volatility like what we are seeing now, investors tend to seek those with higher yields on offer as their values tend to appreciate in the short term.

The same can be said for equity markets. As a broad rule of thumb, equity markets tend to fall in value during periods of weak economic conditions as publicly listed companies face slower commercial activity which typically affects revenues and profitability.

While it may seem counter-intuitive, this is precisely the time when many investors with a higher risk appetite enter the market, as there can still be sectors and individual companies that present a return potential, particularly over a longer time horizon, as economic conditions normalise.

However, both asset classes come with a health warning and are not for the faint-hearted, particularly during periods of market dislocation. You need to expect some bruises along the way as you see the value of your investment go up and down. That's why these investments are more typically suited for people who are in a position to take a longer-term view.

And if you are not confident of doing it yourself but you still want to participate, it is always a good idea to approach professional advisers.

MANAGING RISK THROUGH BLENDED PORTFOLIO

Regardless of the macro-economic conditions, no asset class can excel all of the time.

The only consistency for investors can be in their approach: being clear and disciplined about their wealth goals, seeing wealth as a long-term exercise and looking for a balanced and diversified portfolio.

•The writer is head of wealth development, retail banking and wealth management, at HSBC Singapore.

A version of this article appeared in the print edition of The Sunday Times on August 21, 2016, with the headline 'Getting better returns in an environment of low interest rates'. Print Edition | Subscribe