Cash gains edge on government bonds

The attractive term deposit rates now being offered by the big four banks make government bonds appear less appealing.

The big four banks are lifting their game on term deposits Picture: AAP

In a quirky reversal, the big, bad banks of royal commission days are now being asked to come to the rescue of businesses and individuals caught up in the savage coronavirus whirlwind.

As well as deferring payments and extending credit, encouragingly they have also increased term deposit rates.

The biggest business lender, NAB, is leading the four majors with a rate of 1.75 per cent per annum for a 10-month term deposit. CBA is showing 1.3 per cent per annum for eight months and 1.7 per cent for a year. ANZ has also come to the party, offering 1.35 per cent per annum for eight months. Limits apply.

Westpac has a more comprehensive offering but is last to come to the market, with these rates available from March 27. Its one-year rate is 1.7 per cent, with interest paid monthly.

Moreover, Westpac has added an innovation: for Australians aged 65 years and over, the rate is a high 2 per cent per annum for eight months — both options up to $500,000 per customer.

For conservative investors, the limited but clear trend of banks beginning to lift term deposit rates towards more acceptable levels is worth noting. Put simply, these attractive deposit rates are making government bonds less appealing.

Indeed, Australian government bond rates look meagre by comparison. Since quantitative easing began, short-term rates have been pushed down towards the RBA target of 0.25 per cent out to three years. After three years, they rise steadily to about 0.9 per cent for 10 years. With ­little prospect of negative interest rates and the resultant price ­appreciation for the bonds, deposits remain the better-yielding alternative.

Still, investors always need to consider diversification.

Government bonds are key defensive assets in the world’s largest portfolios. Most large institutional investors have mandates requiring minimum invest­ments in global AAA-rated sovereign bonds. The Australian government is one of only a handful of sovereign issuers to meet the hurdle.

When financial markets deteriorate, institutional investors flock to “safe haven” government bonds, but few private investors understand the benefits.

Government bonds tend to outperform when prices of other assets decline. The bonds offset losses and help to cushion your portfolio from the turmoil. As markets are generally unpredictable, government bonds provide unrivalled protection.

There are a range of government bonds listed on the ASX, and there are dedicated government bond ETFs and others with a majority holding.

Just now there are opposing views as to whether it’s worth ­investing in the market. In summary, the arguments in favour of investing in government bonds point to these features:

• A safe-haven asset where bond prices can increase providing an unexpected gain if sold prior to maturity.

• Performance is not tied to the economic cycle. Sovereigns print money and collect taxes, ensuring the $100 face value of the bonds is repaid at maturity.

• Investors have a much-prized government guarantee.

• Income is fixed and paid half yearly, providing great certainty.

The argument against would include:

• While the RBA has committed to buying bonds along the curve to support the market and has been effective in the early days, when the commitment to 0.25 per cent three-year government bond yields was announced, the 10-year yield spiked. The market was hoping for a formal target for 10-year bonds as well. The dislocation shows there can still be volatility in very-low-risk government bonds, although I expect with central bank intervention this should ease.

• Projections to support the economy through the pandemic are underestimated and greater assistance requires greater government bond issuance.

• Very low yields to maturity.

• Potential for interest rates to rise and the face value of the bond to decline.

Gary Norden, a hedge fund manager at NN2 Capital, thinks the government should consider tax incentives. “We need to ­explore the potential for investors to be offered tax incentives to ­invest in Australian government bonds,” he said.

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