The chairman of the $166 billion sovereign wealth fund, Peter Costello, has warned that record low interest rates are pushing investors into risky financial products akin to “collateralised debt obligations”, which blew up during the 2008 global financial crisis.
Mr Costello said the shift up the “risk curve” by unsuspecting retail investors was compounded by extra regulation on banks spawning riskier “shadow finance” institutions, including Afterpay, Latitude Financial and non-bank lenders.
The Future Fund chairman and Australia’s longest-serving treasurer said mum and dad investors, including retirees, were being lured by advertised investment yields of 5 per cent.
However, they had little idea they were taking on significantly more risk that would be exposed by future market turbulence.
“Retirees would normally get returns out of a term deposit, but interest rates are now so low you would be lucky to get 1 per cent,” Mr Costello told The Australian Financial Review.
“If you are looking for a 5 to 6 per cent return these days, you are in risk assets – not bank term deposits.
“The newspapers are now full of how you can invest with various financial companies.
“Basically what is on offer is CDOs, collateralised debt obligations – the things that fell over in 2008.”
The Financial Review has previously reported that some financial firms were offering investments in subprime mortgage funds, listed junk bond funds and other riskier products, and advertising them like bank term deposits.
Mr Costello said individual investors and superannuation funds must focus more on “risk-adjusted returns”.
Asset prices were very high due to ultra-low interest rates around the world, he said.
“Low-interest rates can’t last forever and when they rise asset prices will normalise,” he said.
More broadly on the finance sector, Mr Costello said an unintended consequence of the banking royal commission and the corporate regulator’s tougher enforcement of responsible lending laws was that “badly behaved” banks were facing a major new regulatory burden that was restricting the flow of credit.
“The flow of credit is being restricted out of the regulated banks and Australia is developing a huge shadow finance system which is hardly regulated at all,” he said.
“If we were looking to China and this was happening we would be worrying about the shadow finance system and asking where the prudential regulation is.”
Fintech groups Latitude Financial and PayPal Australia have joined the major banks and insurers near the top of a list of the most complained about financial services companies, according to data from the Australian Financial Complaints Authority.
The big four banks, which are being layered with new regulations following the Hayne royal commission, are losing market share to non-bank lenders and fintech start-ups offering cheaper loans and credit-like services to buy products.
Mr Costello, who is also chairman of Nine, owner of The Australian Financial Review. served as treasurer for 11 years in the Howard government and is a confidante of federal Treasurer Josh Frydenberg. He is critical of the Reserve Bank of Australia for dropping the official cash rate to 0.75 per cent last year.
“The Reserve Bank’s last couple of interest rate cuts didn’t do much for confidence at all, but they set off the Sydney and Melbourne property market again which is not a good thing,” Mr Costello said.
“They’ve set the housing market off again.”
Market economists expect the RBA to cut the cash rate again this year to 0.50 per cent, possibly as early as February.
Future Fund firing
The Future Fund was founded in 2006 by the then treasurer to strengthen the Commonwealth’s long-term financial position, particularly to cover the government’s unfunded superannuation liabilities for public servants.
The fund delivered an annual return of 11.3 per cent in the 12 months to September 30 and earned a 10 per cent annual return over 10 years, easily exceeding its benchmark target of 6.5 per cent a year.
“What counts is the risk-adjusted return,” Mr Costello said.
“In markets where low-interest rates are bidding up asset prices, the fact that you show a larger return means nothing if all you’ve done is taken more risk than everybody else.”
The superannuation regulator in December exposed the $43 billion industry superannuation fund, Hostplus, for being heavily weighted to risky assets in its “balanced” fund.
The Australian Prudential Regulation Authority’s heat map assessed Hostplus’ flagship MySuper product as having a 93 per cent allocation to growth assets.
This enabled the $43 billion industry fund for hospitality workers to top the league tables against funds with growth asset allocations of between 60 to 80 per cent, although Hostplus insists the 93 per cent figure is “misleading”.
Mr Costello and Future Fund chief executive David Neal have made a big deal about the sovereign fund’s strong focus on delivering “risk-adjusted” long-term returns that hold up better than super funds in times of market turbulence.
Mr Neal has said the fund’s diversification helps manage risk and it has the flexibility to adjust the portfolio as the investment environment changes.
The fund held 11.4 per cent of its assets in cash, 7 per cent in Australian shares, 19.2 per cent in foreign, developed market equities and 10 per cent in emerging market equities.
The Future Fund also held 6.7 per cent in property, 7.1 per cent in infrastructure and timberland, 9 per cent in debt securities and 13.7 per cent in alternatives such as hedge funds.
While experts caution against comparing the Future Fund’s returns with super funds because of the former’s tax advantages, the Future Fund presented a slide to show in August that after adjusting for tax, it has returned 10.5 per cent per annum over the 10 years to June 30.
This is better than typical super funds and in line with the top-performing growth super funds after adjusting for tax.
The Future Fund says it has achieved this with about half the volatility, implying it takes less risk.