Maximising your returns
As investors seeking to maximise your returns, you are well aware of the challenges of investing in a low-yielding environment. Apart from record low yields, investors are confronted with negative real returns, poor asset availability and, for those seeking to invest abroad, scarcity of US dollars. Against these seemingly daunting odds, many local investors are now left with the task of seeking out relatively good yields without sacrificing too much in the area of quality. In an effort to aid you in this quest, we outline here some of the main issues faced by the local fixed income investor, before suggesting some ways the local investor can seek to maximise returns despite these challenges.
Why are interest rates so low?
With short-term interest rates continuing along a downward trajectory, local investors are finding it increasingly difficult to obtain relatively attractive returns in the current environment. The slump in interest rates over the past five years is attributable to numerous factors; among them the current state of the local economy and liquidity levels within the financial sector.
Following the global economic downturn in 2009, local interest rates declined significantly as the Central Bank adopted an accommodative monetary stance, which was reflected in the lowering of its main policy rate, the Repo Rate. The fall in the Repo Rate was followed by the concurrent lowering of all other local interest rates including the 3-month T-bill rate and commercial bank deposit rates to record low levels. For instance, commercial banks ordinary savings deposit rates fell from 1.75 per cent in January 2008 to the current rate of 0.20 per cent.
Another factor which contributed to the record low interest rate environment is the accumulation of excess liquidity within the financial sector. The liquidity overhang which plagued the local financial system during the first half of 2012 is attributable to substantial net fiscal injections and the relative scarcity of TT$ investment opportunities. However, there has been some success in mopping up excess liquidity following the Central Bank's adoption of several liquidity absorption measures including the voluntary placements by local commercial banks. Consequently, over the past two months, commercial banks excess liquidity remained flat at TT$2.2 billion, from the high of TT$6.5 billion in March 2012.
Challenges for the TT$ Investor
The depressed interest rate environment is not the only concern of local investors. The recent acceleration of headline inflation has adversely affected the real returns earned by investors. Real returns are your investment returns adjusted for the effects of inflation. Given that short-term instrument rates offer yields of 0 per cent to 2 per cent, and June's headline inflation rate came in at 11 per cent, most local investors are earning negative real rates of return. This is illustrated in Exhibit 1 which depicts the downward spiral of real returns over the past 12 months. Essentially, the negative real rate of return indicates that investors' purchasing power is reducing at a faster rate than their earning power.
Another cause for concern for the local investor is the continued depreciation of the TTD against the USD in recent years. Trinidad and Tobago enjoys a managed or dirty float exchange rate, which means the Central Bank controls demand and supply and can intervene to change the direction of the currency. Locally, the supply of USD is tight as many investors are looking to go out to either preserve their USD or convert TTD to USD in anticipation of further pressure on the currency. As such, many locals have been forced to join queues when attempting to source USD from commercial banks.
What can you do?
For the typical local investor, the traditional 60:40 allocation of bonds and equities is applicable. However, we see more opportunity for yield pick-up in the fixed income space. Amidst the challenges presented above, Bourse recommends that you rebalance your portfolio, extend your investment horizon and change your currency mix to consider international investments.
Firstly, by increasing your investment horizon and move away from short-term instruments into the medium or long-term, TTD investors can take advantage of the higher yields available for longer-term investments such as Government of Trinidad and Tobago bonds or state agencies bonds. However, there is limited supply of TTD bonds given that bond auctions tend to be few and far between and investors tend to hold their bonds to maturity, resulting in limited trading on the secondary market. Investors are urged to remain vigilant and take advantage of opportunities as they arise on the local market.
One such opportunity is the National Insurance Property Development Company Limited (NIPDEC) bond auction, the first public auction for 2012. NIPDEC's TT$339 million 13-year 5.15 per cent bond will be issued on August 22, 2012. Investors can place bids via any of the 11 Government Securities Intermediaries, including Bourse; which accepts competitive and non-competitive bids. Based on our analysis, the bond is fairly valued, however, we believe it is likely to be oversubscribed and the issue yield may come in lower than the coupon rate.
Another strategy the local investor can utilise is to adjust their portfolio currency mix. Conservative fixed income investors can consider a 50:50 mix of TTD and USD assets. While accumulating the USD may be a lengthy process, investors should be aware of the advantages of owning USD. Holding USD hedges against any further deterioration of the TTD and also allows the local investors access to international market.
Investing in the international markets allows investors to alter their portfolio mix to include assets other than traditional short-term instruments such as income funds and fixed deposits. The international USD bond universe contains numerous bonds within various sectors, regions and credit quality, which can aid investors in diversifying their portfolio.
Currently, investment grade bonds with maturities ranging from 5-7 years can provide a return of 4 per cent to 5.5 per cent if held to maturity. These bonds can be acquired by investors who are interested in altering their portfolio mix to include USD assets with a medium-term outlook. This will be a superior investment play than holding short-term bank deposits which are currently yielding less than 1 per cent.
While the current low interest rate environment is providing some challenges in obtaining acceptable returns, the local investor should not give up hope. Rather, investors should take advantage of this opportune time to rebalance their portfolio mix. By diversifying their portfolio away from short-term instruments investors can obtain higher returns by investing in medium-term instruments. Also, USD investments will assist in hedging against any further currency depreciation while simultaneously provide an opportunity to obtain higher yielding assets with superior credit quality and diversification benefits. Before making any decisions, investors should seek advice from a qualified investment advisor who can provide thorough research and consultation.