With cash looking set to deliver negative real returns in the years to come, savvy investors are seeking alternative opportunities to achieve diversification and growth within their portfolios.
Following the Australian government’s massive stimulus initiatives to keep the economy afloat during COVID-19, the Reserve Bank of Australia (RBA) has pledged to keep interest rates low for the next few years. It’s likely it won’t be until early 2024disclaimer that the RBA raises its cash rate higher than its current record low of 0.1%.
What’s more, with inflation generally tracking higher than interest rates, holding your money in cash and low-risk options will likely create a deflationary effect on the real value of your existing cash investments. As a result, Australian investors will likely need to move further up the risk curve to earn the same level of returns they were receiving before the pandemic.
So, what does this mean for your investment strategy overall? And how can you capitalise on the current economic environment to build more wealth?
Why your current strategy mightn’t be as effective any more
Savvy investors are aware of the need to consider the risk in their portfolios, as well as which markets they want to invest in, the liquidity of their investments, and how long they want to invest for.
With this in mind, many investors previously used what’s known as the ‘barbell strategy’, as a way to diversify a portfolio against risk while seeking higher returns. Such a portfolio combines a higher proportion of low growth but typically safe assets (such as cash, term deposits and bonds) with a smaller number of riskier but high-growth assets (such as equities). It also tends to shun other investments with risk profiles that are considered ‘middle of the road’.
While this strategy may have worked in the past, it’s no longer providing the same secure level of diversification.
Instead, some investment experts believe that the current environment requires a more nuanced approach. According to ANZ Private’s Head of Research and Governance, Ben McBride, the strategy that investors take will likely vary depending on their individual needs and risk profile.
“I think it’s important for investors not to go from one extreme to the other – that they continue to take a balanced approach” he says, “There’s a vast array of investment opportunities out there to explore.”
Alternative strategies for better returns
The good news is there are investment alternatives to cash and shares that may be able to help investors achieve better returns than cash. However, these investments are less well known and understood in the Australian market.
Due to their unfamiliarity, McBride notes that Australian investors have previously stuck with traditional investments such as cash and home equity. “The fact we’ve had historically higher interest rates compared to the rest of the world has meant that Australian investors haven't had to be as adventurous,” he says. “We're now in a position where we may be compelled to look at the other investment options out there.”
McBride says high-yield debt is one part of the market that’s has historically offered quite strong risk-adjusted returns for investors. They have higher interest rates but lower credit ratings, and they’re often seen as riskier than some other assets.
“High yield debt would not typically be a large allocation in your portfolio, but it’s an area where you could consider having exposure in terms of broadening the diversification of your overall fixed income portfolio,” McBride says.
Seeking high-yield debt for your portfolio
Unfortunately for Australian investors, there isn’t a big local market for high-yield debt assets. McBride says investors interested in exploring these investments need to search abroad - adding a layer of complexity to investing.
“Because many Australian investors are less familiar with international markets, they are hesitant to look to the US or Europe for exposures to high-yield debt,” he says. “On top of that, investors must deal with some added currency risk as well.”
Therefore, investors need to understand what role these riskier debt assets could play in their portfolios, and make sure they understand what they’re investing in.
With this in mind, McBride says that it’s important to seek advice from an adviser experienced in these types of assets. They can help you identify investment opportunities and provide tailored advice and education.