This article originally appeared in the NZ Herald.


The Official Cash Rate reduction this week, from 2.25 per cent to 2 per cent, is a major concern for bank depositors. These investors face further interest rate declines even if the banks don’t immediately reduce their deposit rates following the latest OCR cut.

A further OCR cut – a possible 0.25 per cent to 1.75 per cent in November – will put even more downward pressure on interest rates.

This is a huge dilemma for investors as bank and non-bank deposits represent 23.4 per cent of total household financial assets and are an important source of income for a large number of retirees.

The accompanying table, which is based on Reserve Bank of New Zealand data, shows that total household financial assets have surged from $251.1 billion to $656.5b since 2000.

These figures do not include owner-occupied residential property.

The increase in wealth is due to a number of factors. These include the sale of family-owned farms and businesses, the sale of residential property and surplus land, the increase in the value of unincorporated and incorporated businesses, KiwiSaver and higher saving rates by high-income earners.

The four main areas of household wealth are equity in unincorporated businesses, bank deposits, unlisted businesses and superannuation, including KiwiSaver.

Unincorporated businesses include the equity in non-corporate farms, rental properties, sole traders, partnerships and trusts. These figures are based on book value estimates except for the net value of rental property which is included at market value.

Unincorporated businesses have risen from 24.3 per cent of total financial assets to 27.0 per cent since 2000 but they could be closer to 30 per cent because the $177.1b figure has remained unchanged since March 2015. The equity value of rental property will have risen significantly since March 2015 although farm values have declined.

The next major item is bank deposits, which now represent 21.8 per cent of household financial assets compared with only 15.7 per cent in 2000. The massive increase in bank deposits, from $39.5b to $143.1b since 2000, is indicative of the increasingly dominant position of the Australian banks in New Zealand and our conservative approach to savings.

The strength of the banking system was confirmed this week when ASB, which is 100 per cent owned by Commonwealth Bank of Australia, announced a strong result for the June 2016 year.

Household bank deposits have increased by $103.6b since 2000. This compares with increases in superannuation assets, including KiwiSaver, of just $36.6b and only $20.1b for NZ-listed shares.

As the benchmark NZX index has risen more than threefold since 2000, and the amount of household investments in NZX shares has risen by less than this amount over that period, it is clear that investors find bank deposits more attractive than NZX-listed companies.

New Zealanders have an unusually high level of bank and other deposits compared with other countries. For example, New Zealanders have total bank and non-bank deposits of $153.7b compared with superannuation/KiwiSaver assets of only $67.7b while Australians have total deposits of A$957b compared with A$1.99 trillion of superannuation assets.

The issue with interest-bearing deposits is that they offer low returns in the current environment, particularly on an after-tax basis.

One of the best ways to measure the investment performance of deposits is the S&P/NZX Bank Bills 90-Day Index. This index appreciated by 32.3 per cent between March 2008 and March 2016 while the benchmark NZX50 Gross Index rose by 94.6 per cent over the same period.

The problem with bank deposits, as measured by the Bank Bills 90-Day Index, is that the return on this investment continues to decline. In the eight years to March 2016 the index had an annual return of 3.6 per cent. This declined to 3.2 per cent for the year ended March 2016 and only 2.8 per cent in the past 12 months. These returns are before tax and the tax impost on deposits is higher than on NZX-listed company returns.

This week’s OCR cut, and the prospect of a further reduction before the end of the year, clearly indicates that the return on deposits will continue to decline in the short term.

This is one of the main reasons why high-dividend-yielding shares are attractive.

However, investors should take a selective approach towards sharemarkets because listed company values are high and the NZX, in particular, has had a strong run. The third largest household financial asset class is New Zealand unlisted shares.

These are shareholdings in domestic businesses that are not listed on the sharemarket. There has been a dramatic increase in the value of these businesses since 2000 but the total value in the Reserve Bank database has remained unchanged over the past 12 months.

The fourth largest asset class is superannuation, including KiwiSaver. This figure does not include the New Zealand Superannuation Fund but it includes an estimate of unfunded superannuation. The latter are superannuation entitlements not covered in full by the amounts that are held in superannuation funds.

KiwiSaver should continue to expand in the years ahead, assuming politicians don’t meddle with the scheme, but the main issue with KiwiSaver is that investors are probably too cautious, they don’t have enough invested in growth assets.

This is consistent with New Zealanders’ overall approach towards financial assets. A very high proportion of non-KiwiSaver, as well as KiwiSaver, funds are invested in conservative income assets.

According to Morningstar’s latest KiwiSaver survey, investors had a 55 per cent allocation to income assets, which is relatively high for a long-term superannuation scheme with a membership median age of 36.

Income-oriented KiwiSaver funds will have to be innovative to achieve annual returns in excess of 5 per cent in the current low interest rate environment.

Financial assets are only part of the household balance sheet picture, the others are owner-occupied residential property and debt.

Household liabilities, mainly housing loans, have increased from $50.4b to $165.7b since 2000 and housing and land values have soared from $181.9b to $657.2b

Clearly, the biggest asset value increase, in relative and absolute terms since 2000, has been residential property.

Overall, the total net wealth of New Zealand households has surged from $380b in 2000 to $807b in 2008 and to more than $1.15 trillion at present.

Finally, the enormous strength of the banking sector was reconfirmed this week when ASB announced a net profit after tax of $913m for the June year compared with $859m for the previous year and $806m for the June 2014 year.

The 2016 year net profit after tax represents a 1.16 per cent return on the bank’s average total assets for the June 2016 year.

ASB’s net profit exceeds the combined net profit of the three largest listed NZX companies – Auckland International Airport, Meridian Energy and Spark. These three companies have a total market value of $22.6b.

ASB has $72.3b of loans with 66 per cent on residential mortgages, 6.6 per cent on other retail loans and the remaining 27.3 per cent to businesses.

Thus, New Zealanders have a strong bias towards investing in bank deposits and the trading banks, including ASB, channel this money into residential mortgages.

In view of this, it is not surprising that New Zealand has such a strong housing market.

Brian Gaynor

Portfolio Manager

Disclosure of interest: Milford Funds Ltd holds shares in Commonwealth Bank of Australia, the parent of ASB, on behalf of clients.

Disclaimer: This article originally appeared in the NZ Herald and is intended to provide general information only. It does not take into account your investment needs or personal circumstances and so should not be viewed as investment or financial advice. If you require financial advice we recommend that you speak to an Authorised Financial Adviser.