Getting the most out of short-term investments
Today, we at Bourse discuss the current local interest rate environment and strategies investors can consider in maximising their short term investment returns. Local investors continue to face the challenge of gaining an acceptable return on shortterm investments, with interest rates being at or near historically low levels for some time. With excess liquidity levels of TT$8.3 billion, the local financial system seems to have much more money than it can put to work. We consider the environment and options for the investor with non-immediate needs for access to cash.
Current State of Affairs
In September 2012, after experiencing sluggish growth in the non-energy sector and ongoing down-time and maintenance in the energy sector affecting output, the Central Bank of Trinidad and Tobago (CBTT) saw it necessary to further reduce the Repo rate from 3.0 per cent to 2.75 per cent. This was done to support recovery in the economy, while taking into account inflationary challenges. Since then, the repo rate has been maintained at 2.75 per cent resulting in downward pressures on domestic interest rates and a build-up of liquidity. As seen in Exhibit 1, commercial banks excess reserves have climbed from a low of TT$2.7 billion in October 2012 to a high of TT$8.3 billion during the first three weeks of September 2013, a year-on-year increase of over 200 per cent.
As seen in Exhibit 2, 90 day Treasury bill rates have declined by 80 per cent to 10 basis points in October 2013, from 51 basis points in October 2012. 180-day Treasury bill rates declined by 62 per cent to 22 basis points in September 2013 from 58 basis points in October 2012.
Investors have seen their deposit account return substantially low rates as ordinary savings deposit rates at commercial banks declined by 55 per cent since January 2010. Deposit rates have maintained an average of 0.20 per cent since July 2011, after weakening from 0.45 per cent in January 2010. The decline in interest rates is also observed in the average money market mutual funds rates offered locally (Exhibit 3). Money market funds have experienced continuous declines both in the TT dollar and US dollar space.
The depressed level of interest rates currently prevailing in the local financial system mirrors the subdued level of economic activity. Following the 2008 financial crisis, interest rates initially declined in the local economy, when the Central Bank on several occasions slashed the Repo rate and adopted an accommodative monetary stance to stimulate economic activity.
The most recent NIPDEC 4 per cent 2029 bond auction provided investors with a 4 per cent coupon rate and 16-year tenor, issued at a price $102.38 per $100 Face Value (3.80 per cent yield to maturity). While this yield is encouraging relative to recent bond auctions which offered 2.5 per cent and 2.6 per cent for 2023 and 2020 bond maturities respectively, a 3.80 per cent yield to maturity is not the most exciting of investment returns for any investor.
The persistent low interest rate environment has left many investors wondering how to secure a reasonable rate of return on shorter-term investments, without facing exposure to inordinate amounts of risk.
Alternative Investment Solutions
For the money market investor, conventional deposits have become the least attractive store of savings and wealth. Money market funds provide an alternative destination for short-term investments; however money market fund rates are also trending downward. An increasingly attractive short-term investment avenue for the risk adverse investor is the Repurchase Agreement or Repo.
The Repo is a short to medium term investment instrument in which the repo issuer pledges an asset (usually a fixed income security) to the repo investor. The official definition of a Repo involves the sale of a security with a commitment by the seller/issuer to buy the same or equivalent security back from the purchaser/investor, at a specified price and at a designated date in the future. Essentially, the investor agrees to lend funds for a specific period of time at an agreed rate, lent against a specific security representing the collateral.
Repos can earn superior returns when compared to money market funds, with the added advantage of earning a fixed rate of return for a specified period of time. Repos are more-secured investment products which can be used by investors to diversify their portfolio. The use of higher quality securities as collateral mitigates the credit risk faced by the investor, in comparison to deposits which are unsecured investments with limited deposit insurance. Additionally they presently offer relatively more attractive rates than fixed deposits, which typically yield less than 1.00 per cent.
The flexibility of a Repo extends beyond the investor’s ability to tailor a personalized, tenor, investment amount and in most cases choice of collateral. The main advantage is flexibility in negotiating the rate of return, where available, in stark contrast to many other short-term investments. The Repo is a similar in economic concept to a secured loan, offering more competitive rates than bank deposits and money market funds, while providing useful employment of cash that might otherwise be left in a bank account earning minimal/no interest.
Repo investments are available to both US$ and TT$ investors and are offered by several financial services providers including Bourse. Investors seeking to strike the best balance of liquidity and a reasonable rate of return on their short-term funds will find the Repo an effective investment instrument. Considering that most money market funds/deposit accounts offer relatively unappealing returns, while fixed income auctions offer bonds with longer investment horizons, the shorter-term investor should consider opportunities, such as the Repo, as an integral part of an effectively managed investment portfolio. For more information on the investment options available, investors are encouraged to consult with a qualified investment advisor, such as Bourse, before making your investment decision.