There are reasonable alternatives: TARA in Australia

Back to the Fed as banking stress fades

The risk of a full-blown banking crisis looks to have abated for now. As conditions stabilise the market’s focus has returned to Fed monetary policy with stubborn wage pressures and OPEC’s surprise cut reminding investors that the fight against inflation is not over yet.

Despite the sell-off of US financials in March, the broader S&P500 index was buoyed by falling rate hike expectations to finish up 3.67% for the month. But at this point in the cycle the S&P500 index looks expensive, trading off a forward PE of 18.7x (as at 19 April 2023). That is nearly as high as when hopes of a soft landing peaked in January. And while nominal bond yields have indeed fallen, the real yields (the component of nominal yields, after removing inflation expectations) remain elevated – compounding equity valuation worries.

To top that off, forward earnings have clear negative momentum, with downward revisions across most sectors and the S&P500 predicted to enter a ‘earnings recession’ this quarter¹.

US investment flows: From TINA to TARA

For the last few years US households have ploughed excess savings into the stock market, but that net buying has reversed in 2023 with $51B year-to-date net outflows from US equity mutual funds and ETFs². This is due in part to a collapse in the US personal savings rate, but also the attractive yields now on offer in fixed and floating rate bonds relative to equities. It appears the TINA trade (there is no alternative to equities) is over and the TARA era (there are reasonable alternatives to equities) is upon us – with very strong flows into bond and money market funds in particular. Goldman Sachs Investment Research forecast US households will be net sellers of US$750 billion in equities in 2023. This amount of net selling would reverse the previous six quarters of household equity demand, a significant headwind facing equities this year.

Source: Goldman Sachs, as of March 2023

Portfolio Implementation in Australia

If the outlook for equities is challenging, where can investors look?

Getting paid for patience:

Many investors are seeking liquid “TARA” investment options that offer the ability to take advantage of any buying opportunities that may materialise in equities. Below are four options where investors can look to “park” capital with the potential for attractive levels of income relative to platform cash solutions or term deposits, with the benefit of T+2 liquidity.

Option 1 & 2 – Cash is king

AAA’s assets are simply invested in cash deposit accounts held with select banks in Australia. As at 18 April 2023, the interest rate earned on AAA’s deposits sat at 3.69% p.a.*, net of fund management fees and costs. AAA’s interest rate has been above the RBA Cash Rate since the Fund’s inception in 2012. AAA has a management fee of 0.18% p.a.**

AAA pays monthly distributions and has the added benefit of being exchange-traded.

Like AAA, USD’s assets are simply invested in a bank account, however it is a U.S. dollar bank account. This Fund allows Australians who are comfortable with foreign exchange rate fluctuations to take advantage of the current higher rate environment in the U.S. As at 18 April 2023, the interest rate earned by USD is 4.38% p.a.*, net of fund management fees and costs. USD has a management fee of 0.45% p.a.**

Beyond this interest rate, USD also provides two very attractive use cases:

1. Historically, the U.S. dollar has tended to behave like a “risk off” or “safe haven” currency relative to the Australian dollar. It has demonstrated a negative correlation to equities, meaning that USD has typically appreciated in value when equity markets have sold off, so can be used for equity diversification purposes³.
2. If an Australian investor is waiting for an attractive entry point to deploy Australian dollar cash into the US equity market they face currency risk. Often the US dollar has tended to rally at a time when US equities have become cheap, as was the case in the COVID lows of March 2020. Rather than risking the erosion of a US asset buying opportunity by adverse currency movements, an investor can park their capital in USD while they wait for that opportunity to emerge.

Option 3 – Floating above cash rates

QPON’s assets are invested in a quality portfolio of capital stable senior floating rate notes issued by Australian banks, which are among the most liquid and highest credit-rated corporate bonds issued in Australia.

In a chaotic 2022 when both government yields and credit spreads blew out, and where many bond funds were down -12% or more, QPON had a maximum drawdown of -1.0%, from which it fully recovered within 4 months. QPON has a current All-in Yield of 4.62% p.a.*, estimated Yield to Maturity of 4.49% and a management fee of 0.22%p.a.** (as at 18 April 2023).

Option 4 – Higher income and diversification away from Australian banks and residential property

HCRD generates an attractive All-in-Yield of 5.93%* and estimated Yield to Maturity of 5.52%*** (as at 18 April 2023) through a portfolio of investment grade corporate bonds, while hedging out the interest rate duration risk. Most floating or variable rate credit available in Australia is issued to fund banks, residential mortgages and/or property developers. HCRD’s issuer profile is somewhat unique in that it has very little banking exposure (~6%), and is instead diversified across defensive sectors like infrastructure (eg Brisbane Airport, Ausnet) and consumer staples (eg Woolworths, Coles). HCRD has a management fee of 0.29% p.a.**

Defending against a US recession:

In March, fixed-rate high grade bonds again showed their defensive attributes against equities when fears of a recession are heightened. In a US recession these bonds have tended to benefit from both a flight to quality from earnings downgrades and a pivot in central bank policy. In addition to equity diversification benefits, the equity risk premium (the amount you get paid for taking equity volatility excess of bonds) does not look attractive – explaining some of the switching from equities to bonds.

Option 1 – Government bonds may provide a “safe-haven”

AGVT invests in a portfolio of relatively long duration Australian government and government-related bonds. AGVT targets bonds with a maturity of 7-12 years seeking to enhance defensive characteristics particularly when compared to the AusBond Govt 0+ Yr Index which has a significant weighting to shorter dated Australian Commonwealth Government bonds (20.4% to 0-3yr bonds as at 31 March 2023). This longer duration profile and high credit quality (average rating of AAA) makes this Fund well positioned to benefit from a recessionary environment. Indeed in March, when recessionary fears heightened around banking stresses, AGVT returned 4.56%. (returns for periods longer than one month are available at www.betashares.com.au) AGVT has a current Yield to Worst of 3.76% p.a.* (as at 18 April 2023) and management costs of 0.22% p.a**.

OZBD is designed to be a core portfolio allocation for fixed income. It aims to track the performance of an index that provides exposure to a diversified portfolio of high-quality Australian government and corporate bonds selected on the basis of risk-adjusted income potential, while controlling for overall interest rate and credit risk. OZBD’s portfolio has provided defensive properties, returning 3.42% during the recessionary fears in March (returns for periods longer than one month are available at www.betashares.com.au), and has appealing income potential with a current Yield-to-Worst of 4.20% p.a.* (as at 18 April 2023) and a management fee of 0.19% p.a**.

• AAA

  Australian High Interest Cash ETF

  Fund page → Download factsheet →
• USD

  U.S. Dollar ETF

  Fund page → Download factsheet →
• QPON

  Australian Bank Senior Floating Rate Bond ETF

  Fund page → Download factsheet →
• HCRD

  Interest Rate Hedged Australian Investment Grade Corporate Bond ETF

  Fund page → Download factsheet →
• AGVT

  Australian Government Bond ETF

  Fund page → Download factsheet →
• OZBD

  Australian Composite Bond ETF

  Fund page → Download factsheet →