Home / Opinion / As ‘normalcy’ returns, investors should rethink their risk appetite

With monetary policy returning to what could best be described as normal settings, investors need to adapt to the changing circumstances, writes Wattle Partners principal Drew Meredith. It's time to move away from risky growth assets and stop building portfolios for a 'zero-rate' environment.

Headlines remain fixated on the negative impact of higher interest rates, whether on property prices, volatility or the cost of living. But while this is clearly challenging for a large cohort of Australia, and many parts of the world, the normalisation of interest rates is a significant positive for those nearing or in retirement.

The key word here is ‘normalisation’, as what we are seeing at the moment is a return of interest rates and monetary policy to what could best be described as normal settings.

The path being taken to get there is highly unusual, to be sure, especially in Australia where the Reserve Bank of Australia has taken the cash guidance rate from zero to 100 in the blink of an eye (or, to be more accurate, from 0.1 per cent to 4.1 per cent in only 15 months).

But the truth is that we seem to have become so comfortable with near-zero interest rates and the associated ease of access to capital that we forgot interest rates were never meant to be that low.

Investors should be rewarded for putting money in the bank, or have the ability to generate returns from low-risk assets.

From the privileged position of seeing hundreds of client investment portfolios every day, I get the feeling that perhaps we haven’t fully adjusted to the changing circumstances. More than that, I believe many people are still building portfolios for a ‘zero-rate’ environment – investing in the assets that did well when rates were falling or had hit rock bottom.

Unlisted assets, such as private equity, venture capital, private credit and direct property, have been among the most popular and high-performing assets in recent years. Most of these are not regularly valued, represent higher risk and attract flows due to (among other reasons) the need to seek returns beyond low-risk investments.

I’m not suggesting these assets should be abandoned or not come under consideration, but rather that investors should proceed with caution and remain vigilant to valuation risks.

In addition, most portfolios continue to rely on risky growth assets – domestic and global equities in particular – for the bulk of their returns, despite increasing levels of volatility and exceptional short-term performances.

Prudent portfolio construction would suggest taking as little risk as possible in the pursuit of client objectives, which we know vary greatly. Yet from our position as retirement-focussed advisers, the ability to generate a significantly higher income, with less volatility via a combination of lower-risk fixed income and related investments, is increasingly attractive.

The last such consideration is that a refocus on strategic asset allocation weightings is warranted. Cash rates close to zero per cent meant that any funds held in cash were a drag on returns for the last few years. Yet having seen term deposit rates now exceed 5 per cent, a case could be made for increasing ‘cash’ weightings from the traditional 2.5 to 5 per cent, towards 10 per cent going forward.

It never hurts to be prepared for the next period of volatility and uncertainty, whenever that may be.

*This article was first published in The Inside Adviser.