Building portfolios with the right mix of growth and defensive assets is an essential part of investing, particularly for older Australians who are focused on preserving as well as growing their hard-earned savings.
However, in recent years striking the right balance has become more difficult as ultra-low interest rates have affected returns on defensive assets. Effective yields of 2 per cent or lower seem miserly, especially as price inflation in everything from food to petrol has jumped quickly in recent months.
The good news is there are still pockets of opportunity in fixed income markets that can provide reliable, consistent income for your portfolio.
As an investor, you are probably very familiar with the Australian banking sector, which is known for its financial strength and significant share of the local market. The latest reporting season saw plenty of good news from the local banks, which have been major beneficiaries of the post-pandemic recovery.
Yet the Australian banks make up just 4 per cent of the global market, leaving a vast universe of untapped opportunity. For this reason, there’s a strong case to look to the global banking sector for your fixed income exposure.
Sound capital positions
The global banking sector has emerged in excellent shape from the worst of the pandemic. Many banks are now in a stronger financial position than before the disruptions began.
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Following the global financial crisis (GFC) in 2008 and 2009, global regulation known as the Basel reforms, forced banks to increase their capital buffers and improve liquidity and solvency measures. These reforms contributed to a 40 per cent increase in average total capital across the global banking sector during the 13 years to 2019.
In coming years, global banks will be in an excellent position to weather further downturns in comparison to other sectors.
Strong brand equity
Banks played a pivotal role in the early part of the pandemic and were often the first port of call for customers as lockdowns loomed. Governments turned to the banks to help implement support measures and act as a crucial intermediary between themselves and the economy.
Actions such as repayment holidays and delaying foreclosures were good business practice – both financially and reputationally.
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Looking forward, global banks look set to continue to benefit from increased customer loyalty as economies reopen and life begins to return to normal.
A more bullish outlook
In terms of the global economy, at Daintree Capital we believe there is a solid platform in place for strong economic growth in 2022. Consumption is expected to revert to pre-pandemic patterns and levels over the next two years as international borders reopen, tourism returns and movement restrictions ease. Households will also be more comfortable to increase economic activity due to high savings.
From a lending perspective, as bank customers reduce their elevated cash holdings, this is also likely to lead to increased credit demand.
Most large banks have reported only a fraction of the losses that were expected to occur because of the pandemic. This has protected capital and allowed profitability to be maintained. And with moderate interest rate increases forecast in the coming years, this would be a further benefit from a profitability perspective.
Accessing the global banking sector
All this being said, the global banking sector is still not without risks. Banks face challenges not just from each other, but from a vibrant fintech sector that is having success attracting younger segments of society and these issues could cause some volatility in bank equities.
If you are seeking consistent returns, we believe fixed income offers the best way to access the global banking sector.
Within the fixed income asset class, our view is that hybrid securities are a smart way to gain exposure to the world’s best banks. Offering returns of between 2.5 and 4 per cent above the cash rate, they provide a compelling alternative to buying bank bonds, for a modest increase in risk profile.
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The good news is, there are now specialist, actively managed funds available in the Australian market to help you access this opportunity.
Conclusion
The banking sector has undertaken a remarkable transition from being the epicentre of the GFC to being an essential conduit of support and a significant beneficiary from the COVID-19 pandemic.
While the nature of the two most recent crises is quite different, the lessons learnt from the GFC and subsequent improvements, particularly in the banking space, have set the stage for a robust recovery that is still in its early stages.
Overall, we see large global banks as viable long-term investment propositions, but the unique features of hybrid securities mean that in the current environment they provide the best risk-adjusted return among the available investment options.
Brad Dunn is senior credit analyst at Daintree Capital.
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Disclaimer: All content on YourLifeChoices website is of a general nature and has been prepared without taking into account your objectives, financial situation or needs. It has been prepared with due care but no guarantees are provided for the ongoing accuracy or relevance. Before making a decision based on this information, you should consider its appropriateness in regard to your own circumstances. You should seek professional advice from a financial planner, lawyer or tax agent in relation to any aspects that affect your financial and legal circumstances.
