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Disruption and the retirement income alternative

people pushing a square circle retirement income alternative

Greg Symons considers falling rates, disruption and what a retirement income alternative to traditional markets may offer in returns.

Asset allocation plays a key role in growing superannuation investments over time. The most recent statistics released by the ATO on asset allocation for the Australian SMSF population show after listed shares, cash and term deposit (TD) investments (at about 23 per cent) continue to be the largest allocation SMSF investors hold in their portfolios. This has been the case for some time, meaning banks and their equivalents continue to be a major part of investor portfolios, whether that be through equity exposure such as investing in bank shares, or by holding cash and TD investments or finally whether it be through borrowings for the purchase of property and other assets.

It goes without saying bank exposure for the typical SMSF investor is significant – they will either hold your property deeds, your savings, your equity investment or (more than likely) all three, meaning some SMSF investors in retirement can have more than 80 per cent of their portfolios exposed to banks. As a result, it is no surprise banks have historically had complete control over where money comes from and where it goes. Attractive lending rates have meant banks have been able to not only snare but shape the investment landscape in Australia – just look at what low-interest rates have meant for most banks’ core lending segment – residential property.

On the retirement income investment side, despite poor bank deposit rates, SMSF investors have been a healthy source of funds for banks, largely driven by two primary factors. Firstly – and particularly after the global financial crisis (GFC) – bank guarantees, although let’s face it, for most this would be capped at $250,000. Secondly, a real lack of choice for investors seeking low-risk, capital-stable options that deliver yields they can actually live on in, or as they approach, retirement.

But investors can reduce their direct banking exposure, maintain or improve the quality of their underlying credit exposures and increase their overall yield as a regular income without dramatically increasing their risk through a new breed of asset managers.

Clearmatch is one such manager that is offering wholesale investors access to institutional bank-quality credit portfolios through a fund structure. By using a very sophisticated investment platform that allows investors to effectively lend to institutional borrowers, Clearmatch provides investors very attractive returns, given the low levels of risk.

Unlike other offerings, transparency is the cornerstone of the platform with the ability for clients to see where their money is invested and how it is performing in real-time.

This is also an attractive option for advisers who have been riding deposit rates lower and lower with their clients. Advisers have not had any real options to add value for a significant portion of their client portfolios, without significantly pushing up the risk curve.

Marketplace lending, peer-to-peer finance, whatever term you prefer, may have been regarded by some as a fad, but it’s still here and bigger than ever. Furthermore, it now has a number of years of track record proving that it does offer a real retirement income alternative to banks for both borrowers and investors. With more and more peer-to-peer and marketplace lenders joining the fray, there is now considerable momentum worldwide. In Australia, there are examples of marketplace lending across a range of borrower segments from residential mortgages, through to corporate and consumer lending – each with its own risk/return and liquidity profiles. What this means for investors is they have a choice about the investment characteristics they can access from credit markets, which can provide further income and diversification benefits alongside their traditional equity and cash investments.

The key to the platform is to bring customer-led empowerment to financial markets and recognising there is a substantial ecosystem of important contributors in the finance industry that can deliver significant value when brought together. Understanding the concept of being able to bring the world of fixed income investment hunters together with quality sources of loan assets can be the watershed moment for investors. Clearmatch’s ability to fund and manage loans from consumer assets to commercial assets, secured and unsecured, and providing access to them in one marketplace is a powerful concept.

Savvy SMSF investors will already be well aware global technology companies are using their vast amounts of rich data, customer trust and massive daily interaction and engagement with billions of users and followers to create new financial products for their customers. The combination of this rich data set, customer trust and huge engagement amounts to massive financial disruption and the Australian banking market is absolutely ripe for it.

Australia is dominated by four banks that are among the most profitable in the world, but average consumers are not really seeing any of the benefits. Instead, they perceive layers of financial middlemen, complicated processes and complex systems, high fees and a general lack of transparency. Scandals, royal commissions and the like all contribute to eroding trust (and poor net promoter scores).

This sustained focus on bank behaviour, coupled with the rise of peer trust in the digital economy, has meant the race is on worldwide for disruptors and incumbents alike to win over a new generation of consumers who favour fast and convenient credit solutions, but also investors who simply need retirement income alternatives with higher yields than they are getting from their bank. As a result, banks are being disrupted in payments, lending and investing from a new breed of fintech challengers. It is like a death by a thousand cuts as the banks are slowly losing important pieces of their value distribution chain.

With the millennial generation driving a digital revolution, a significant proportion of Australians relate to or understand the ‘sharing’ economy and it is shaping behaviours such as carpooling, house swapping, crowdfunding, car-sharing, co-working and outsourcing. They recognise that by removing redundant intermediaries and connecting people directly you can create real value, rather than allowing the middlemen to take all the profit. This is the basis of peer-to-peer businesses, which typically use technology in an innovative way to seriously contradict traditional industries.

While there does remain a role for banks and traditional funders in providing competition, benchmarks for pricing risk and maintaining liquidity in the market, there is most certainly room for non-bank players to build niche credit offerings. Peer-to-peer financial businesses can and are coexisting comfortably with incumbents and offer investors and borrowers new solutions to old problems.

The situation presents the classic innovator’s dilemma: when faced with a potential threat from disruptive technology, should a bank cannibalise its existing margins or keep banking their profits? If it decides to meet the market and move towards what marketplace lenders do naturally, that is, offer more competitive, tailored rates, it may have to reprice a rather healthy back book, which may impact profitability.

It’s a simple equation: if banks provide lower-cost loans to borrowers, or higher returns to investors and depositors, the impact on returns for shareholders. When shareholders are the borrowers or investors, then we have a conflict that can only be resolved by having the investor playing fewer roles in this equation.

Advisers and their clients will recognise immediately there are two sides to these opportunities. Disintermediation opens up investing opportunities that may not necessarily be new, but have certainly not previously been available to direct investors. New investment products that are designed to give investors exposure to bank-quality credit portfolios with reliable returns and reasonable liquidity are exactly what has been missing between the cash and enhanced-cash equivalents and the higher-risk, market-linked alternative fixed-income funds that often provide equity-like returns, with equity-like risk. That is, until now.

It is like a death by a thousand cuts as the banks are slowly losing important pieces of their value distribution chain.

Greg Symons

Self-directed investors might be suffering as a result of falling interest rates in traditionally ‘safe’ investments such as term deposits, but those who take the time to understand the investment opportunities that are arising from disruptors in these traditional markets will discover plenty of opportunities to add diversification and returns to their portfolios.

Through new players in the market, such as Clearmatch, retirement income investors can now reduce their direct banking exposure, maintain or improve the quality of their underlying credit exposures and increase their overall yield without significantly taking on more risk.

The global tech giants are already operating in a similar type of collaborative marketplace. For example, Alilbaba partnered with the biggest marketplace lender in the US to provide its customers in that market with an online credit line to make purchases in the Chinese market. This was all powered by an online lending platform. In addition, Google has formed similar partnerships offering a way for businesses that resell its services to get access to low-cost funding.

Importantly for investors, the system will work better with a ‘diversified treasury’. By balancing borrowers with a varied and deep group of investors, borrowers will not be beholden to the same constraints to which banks hold them today. While it is important to ensure that quality of credit is maintained, the ability to quickly and accurately price risk means borrowers, be it individual consumers or businesses, will be subjected to terms and costs appropriate for them, rather than factoring a higher interest rate for all borrowers in order to cover the default rates of a few.

On the opposite side, investors should be able to determine what return they need to help fund a lifestyle in retirement, for example, and therefore understand how much risk they need to take on to achieve that return.

Smart technology can facilitate this interaction today with investors being able to hold fractional interests in a large number of high-quality loans at predetermined interest rates with very low loss rates historically. Previously these types of loan books have been run by institutional banks and are of very high quality, but instead of having it funded by a bank using investor term deposits, with the bank earning significant margins along the way, it can now be funded by investors who will not have to support associated banking infrastructures.

Ultimately the investor ends up with similar risk, but receives a significantly larger portion of the return towards their retirement income.

With the recent and long-awaited decision of the Reserve Bank of Australia to reduce cash rates to 1.25 per cent on 4 June and banks passing on most, if not all, of this cut to investors and depositors, SMSF investors have been hit hard.

Peer-to-peer financial businesses can and are coexisting comfortably with incumbents and offer investors and borrowers new solutions to old problems.

Greg Symons

Even scarier for investors and advisers alike was the futher cut to 1.00 per cent on 2 July. With nearly one-quarter of SMSF investments exposed to these types of investments, it goes without saying that being able to access the underlying credit assets of the banks without having to pay bank margins, with a better liquidity profile than term deposits makes a lot of sense in offsetting some of these cuts.

The journey for the retirement income alternative is only beginning and success will be achieved when fixed income investment hunters like retirees have been brought together with quality sources of loan assets on a large scale, but done in a safe and responsible manner. Whether it’s vehicle finance, consumer loans, retail loans or other specialised types of finance, the aim is to empower the ecosystem players in the finance industry to take part in this market.

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