Non-bank fixed income deposits (i.e. not term deposits) and their risks October 10th, 2022
Investors in non-bank deposit-type products have been urged to watch out for pay-out delays as interest rates in conventional bank term deposits begin to rise.
Popular with retirees, many are now actively weighing up the risks of remaining in funds that are backed by mortgage assets, Australian cash and other credit instruments.
One product offered by one promoter, for example, is currently paying more than 3 percent per annum with rates able to change up or down monthly. They classify this as a low-risk investment in accordance with a guidance paper issued by the Financial Services Council, an industry association.
While these funds have been heavily recommended by some financial advisers, others warn that investors should be aware of the underlying risks. You need to understand why they receive a higher rate of interest than bank accounts.
The money you invest with fixed interest type investment funds is on-sold to people like property developers and others. The return of your money ultimately relies on the borrowers paying back their loans. In the past, the extra interest rate offered for the added risk compared to bank deposits was attractive, but the gap is now narrowing.
Online bank Macbank for example, is currently offering a 6-month term deposit paying 2.9 percent per annum with a number of smaller banks paying more than 2.6 percent for a similar term. Unlike most fixed-income funds, these rates are fixed at the start and can’t be varied by the bank.
The key issue is what happens to your invested capital when the investment matures.
In the case of a bank term deposit, the invested capital plus interest is immediately returned to you or, you could opt to roll the money over to a new term deposit with the same bank or another.
Importantly, the money in a term deposit is ultimately backed by the Federal Government’s Financial Claims Scheme. This guarantees the first $250,000 per account holder per authorised deposit taking institution.
There are no guarantees with other fixed-income type investments. You could lose all or some of your invested capital.
In the case of our high-income investment, the organisation requires you to lodge a redemption request and will endeavour to pay out the investment within 180 days of the request. However, the organisation highlights that the product disclosure statement states that they have up to a year to return the invested funds.
There is no suggestion that these cannot meet their current redemption request within the times indicated. But we need to constantly weigh up the risk and return trade-off.
And we can understand why someone would be chasing a better rate of return when a term deposit was paying 0.4 percent per annum and these alternatives were offering 6 or 7 times that.
But here’s the catch. If the safe bank-account rates keep going up and if a whole lot of investors decide they want to get their money out at once to chase the safety of bank accounts now paying a similar return, things could get tricky.
If there’s no new money coming in, these funds can’t just call in the loans they’ve made to satisfy the withdrawal requests.