How Australians can take advantage of rising interest rates

While rising interest rates are good for term deposits savers, there are other investments that deliver higher returns and also offer more flexibility.

While the big banks have raised interest rates on term deposits and savings accounts, interest rates on many of these products remain below 5 per cent and closer to zero after adjusting for inflation. The average advertised interest rate on three-year term deposits is around 4 per cent, virtually unchanged from a year ago, according to the most recent data from the Reserve Bank.

In addition to relatively low returns, term deposits often involve locking up your money for long periods of time; savers won’t be able to access their money during the fixed period. Interest rates, too, are fixed for a term deposit and remain unchanged for the entire term, even if official interest rates rise.

Yet, some investments benefit from higher interest rates and offer more flexibility than term deposits. This includes fixed-income investments, which have “floating rate” coupons or returns. Floating-rate investments, including corporate loans made by private credit funds, offer an interest rate that is linked to variable interest rates, so returns on private credit funds will generally increase in a rising rate environment.

The potential for another official rate rise before the year is out means that the yield earned on private credit could increase over the next 12 months, unlike the interest rates on one-year or three-year term deposits, which are fixed for the term.

For income-seeking investors who are willing to take on more risk than that involved with cash or term deposits, private credit investments can deliver yields close to 10 per cent a year, almost double typical yields on cash, and up to four times the yields on rental properties, which often fall below 5 per cent.

That is one of the main reasons that Australia’s largest institutional investors, such as AustralianSuper and UniSuper, have allocated more to private credit assets in recent times. In the case of Unisuper, over the past 18 months, the biggest new investment allocations UniSuper had made had been in the debt markets, not equity, its chief investment officer, John Pearce, told The Wall Street Journal in April. While the pension fund was holding back on allocating any more to corporate bonds, it said it was still taking bets on private credit.

Over time, we expect individual investors to follow the lead. Private credit investments do not attract the large stamp duty impost or require a large initial deposit such as is required for residential property purchases. Instead, private credit is accessible and offers reliable income for all investors, including retirees, which is why super funds are piling into this asset class. Another benefit of floating rate loans is that they typically display a low correlation to equities, so this asset class may help to insulate against share market declines.