The dangers of the search for yield
12 May 2015
The unusually low interest rates across the developed world have created a search for yield. The cash rate is now 2% and may go even lower. In such an environment, investors can make decisions that may not turn out to be sound in the longer term. One potential trap is that a yield may look alright, but the capital value may turn out not to be in the longer term.
That is the potential problem described in an article in the AFR. It relates to SMSFs buying into shopping centres:
"Wealthy private investors who have been buying small neighbourhood shopping centres through self-managed super funds are likely to be the first to feel the sting of having paid too much in an aggressive hunt for yield, says Trevor Cooke, the new head of the funds management arm of developer and funds manager Commercial & General.
Mr Cooke, the former head of UBS Global Asset Management's Asia-Pacific real estate operations, said that while it may take time for the full impact of those poor decisions by self-managed super funds to feed through the system, it will eventually result in a destruction of wealth for those individuals. He said generally, it was people running their own SMSFs who had made their money outside of real estate investment who were making bad decisions in some instances.
He said institutions had generally remained disciplined in their investment decisions during the past few years but as interest rates went lower and lower, there were some individuals paying way too much for smaller, neighbourhood-type shopping centres.
A buyer purchasing a $4 million neighbourhood centre on a "sub-4 per cent yield" was distorting things too far and not pricing risk correctly for the lifetime of the asset.
"That's when you start to worry," Mr Cooke says.
Mr Cooke believes on the current economic evidence, it is unlikely that the Reserve Bank of Australia will cut interest rates again in this cycle but that interest rates will stay low for an extended period.
"I think this new normal is a good environment for real estate as an asset class," Mr Cooke says."
The problem with the current market situation is that it is difficult to identify any easy choices. But as the US economy recovers, albeit in a stuttering fashion, and the global economy slowly emerges from the effects of the GFC, it is reasonable to say that the markets will return to something more like normalcy. And in normal times the usual principles apply: risk management should match the investor's stage of life, asset allocation is critical and unnecessary gambles should be avoided.