Here at burningpants, we have decided to compare Australia’s interest rate regime to our international peers the US, and the UK, to see whether we are getting the short end of the stick in terms of the interest rate that we actually pay the banks, and the interest rate that is set by the RBA.

In Australia and the UK the mechanical method for targeting interest rates by the RBA and Bank of England, comes from the interaction between the central bank and commercial banks (CBA, Westpac, ANZ and NAB).

Commercial banks are required to hold a certain percentage of short term treasuries which are issued by the central bank, and lent to banks at the official cash rate in order to undertake open market activities.  As a large portion of commercial banks’ funding is drawn from borrowing from the central bank, the official cash rate has a direct effect on the rate which commercial banks will loan at.  The remaining funding for commercial banks’ loans comes from deposits, bonds and equity, and is subject to a market rate.

In the US the system is similar, where the Federal Reserve lends at the Federal Fund Rate, which is passed onto consumers who hold variable rate mortgages in the form of the prime rate (the Federal Fund Rate plus 3%).

The chart above shows interest rates for the US, the UK and Australia since 1999, and reveals Australia has the most stable interest rate regime of the three, with annualised volatility of 3.3%, compared to 6.7% in the UK, and 7.4% in the US.

We can see how the US housing bubble played out where several years of very low interest rates allowed housing prices to increase in value, incentivising banks to lend to riskier and riskier borrowers in order to maintain profits. This bubble caused the global financial crisis (GFC), which caused downward pressure on interest rates in order to stimulate growth.  We can see this in the historically very low official interest rates in the US and the UK.

In contrast, the economy in Australia weathered the global financial crisis better than most advanced economies, avoiding recession having ridden the GFC out on the coattails of the Chinese dragon’s hunger for Australian mineral exports.  The Australian economy was ticking along well enough to justify increased interest rates in 2009 and 2010.

Following the GFC, there has been a growing gap between the official target cash rate promoted by the RBA in Australia, and that of average Australian Equity home loans.

The graph below shows how this gap is growing, with average Australian Equity Home Loans represented by the red line, the target cash rate represented by the blue line, and the difference represented by the green line.  The difference was a stable 1.8% up until 2008, when citing increased funding costs on international markets the banks began to increase their rates independently of the RBA.

The latest estimates have the difference at 3.1%, though we could expect this gap to continue to increase considering that all of the major banks have increased their variable mortgage rates in February 2012, while the RBA left the cash rate on hold.

The independent movement of the banks is leading to a situation where the RBA’s impact on monetary policy is less effective than it has been in the past.

Australian bankers, such as Ian Narev, CBA’s new CEO, have stated that international markets have increased the cost of funding for Australian banks, and this is why the difference is appearing.  However at the same time Australian savings rates have increased in response to recent economic turmoil.

The real question remains whether the current gap will continue to grow, or remain at a stable level once these global sources of capital start to become cheaper.

Note: All data referenced in this report was accessed from the RBA statistics website in February 2012.

Cash still remains the most attractive asset class in Australia and let’s face it, currently as an asset class it ticks all the boxes providing security, a solid return and liquidity.

But while it’s too early to get too excited about this, there are the early signs that some of the gloss is starting to come off and that the money may eventually be on the move.

Before we talk about that, let’s look at what is actually going on. While system growth for cash as an asset class remains strong on an annualised 7.7% , the growth in the quarter to the end of December was 2.6% of system (or $14.9 billion), down from the 3.3% growth in the quarter to the end of September 2011.

The lion’s share of this money is going to CBA, which receives 26.4% of all of Australia’s retail savings and Westpac which receives 20.1%. The profitability of this book is somewhat skewed by the fact that CBA is refusing to play the aggressive rates game and relying on its position as the ultra-secure bank to generate growth and the research shows it’s clearly the strongest brand in the market.

Who Do You Perceive As The Strongest Brand To Invest With?

Though it’s worth noting here that CBA is the only bank of the big four to grow slower than system this year, registering a pedestrian 5.5%, its rivals exceed system growth.

Westpac ended the year with 8.1% growth and both ANZ and NAB broke double figures with ANZ returning a whopping 13.3% growth in its book while NAB mustered 11.9% growth largely driven by its Ubank subsidiary.

Here at burningpants we’re fascinated by how and when the drive to cash will end and which of the businesses will profit from it.

For the past three months we’ve been working on the post-cash report, conducting research to understand the investment intentions of Australia’s rich (more than $1 million outside their home and their super) and mass affluent (earning between $80,000 and $149,000 a year).

The interesting news is that while about a third of Australia’s HNWIs are going to continue tipping into cash (not an incidental number given there are about 200,000 of them), around one quarter of rich Australians are intending to invest back in the market.

What Do You Plan To Do With Your Cash In The Next Six Months?

What’s more interesting to us at Core Data is which institution they want to invest with when they move on from cash.

We asked this question of both Australia’s Mass Affluent and HNWI and there was a clear and unequivocal winner. CBA looks set to dominate the transfer of assets from cash to something more interesting and more lucrative.

But the latest unemployment figures from the Australian Bureau of Statistics (ABS) tell a different story. Australia’s unemployment rate fell to 5.1% in January, the lowest level since mid-2011, with total employment rising by more than 46,000 jobs to 11.4 million last month – the biggest increase in employment in more than 12 months.

Full time employment rose 12,300 to 8.05 million and part-time work rose by almost three times that – 34,000 jobs – to 3.4 million.

So how can we reconcile this in light of the many redundancy announcements, initially in the manufacturing sector, then retailing and now banking?

It’s partly due to the fact that the number of jobs being lost are just a very small fraction of the total number of people in the labour force (11,421,300 people), but it’s also due to the amount of turnover in the labour market.

Just as quickly as jobs are going, new jobs are being created – particularly in the mining states of Western Australia and Queensland, both of which added 20,000 new jobs in January.

If you’re in a position responsible for hiring staff, we want to hear from you. Has the task become easier or more difficult in the last year? What are the hurdles to your recruitment process?

To take part in CoreData’s ‘Is there a Skills Shortage’ survey, please click here*.

The survey will only take 8-10 minutes to complete and in appreciation of your time, your details will be entered into a prize draw upon the completion of the survey to win an iPad2 with Wi-Fi + 3G 16 GB to the value of $729. There will also be 50 runner up prizes of a $50 gift card to spend at your choice of Coles Group & Myer, Bunnings Warehouse, JB Hi-Fi, Westfield or Rebel Sport to be given away.

*This survey is only open to Australian residents.

Continued downward pressure on pricing, ever increasing regulatory demands, the rise of more sophisticated passives, greater frequency of periods of volatility, growing consumer sensitivity to fees and charges and structural industry shifts forcing distributors to lean on asset managers are just some of the reasons asset management firms may not feel rosy today.

One of the other areas managers can compete, in addition to sucking in money to manage, is the cost of doing business.

The industry tends to regard fund flows as the ultimate determinant of success, however if this success is due to a high cost of acquisition then unless the flows are sticky then it’s highly likely the asset managers actually lose rather than gain.

As an example, Aberdeen Asset Management saw £2.8 billion of funds walk out of the door in 2011 as investors took flight from emerging market investments.

To bring in this money in the first place would have cost the group a great deal of time, effort and resources.

With this in mind, CoreData Research UK is conducting a study to measure how effective managers are when it comes to business efficiency.

In this study we utilise a measure of managerial efficiency, known as cost efficiency or X-efficiency, to explore the relative efficiency of Britain’s asset management industry.

In calculating such a measure we can establish how management can best increase overall efficiency and reduce waste in their institutions in the best interests of their customers and shareholders.

The concept of X-efficiency departs from the hypothesis that economic efficiency, based on perfect competition assumptions, does not hold in reality.

Thus, assessing the performance of asset managers should not be done in relation to the theoretical ideal of efficiency, but to a benchmark elaborated on the basis of empirical observations.

Through stochastic frontier analysis (SFA), the study uses industry data to estimate a hypothetical efficient frontier formed by the points where costs are minimised for every level of output.

An efficiency score is then calculated for each firm by evaluating their cost/output combinations in relation to those on the efficient frontier.

Graphically, this score can be conveyed as the distance between the firm and the efficient frontier on cost/output space.

The study obtains the efficiency scores, ranging from 0 (absolute inefficiency) to 1 (efficiency), for listed asset managers in the UK and compares their relative performance in using the resources available to them and reducing the cost of doing business.

The use of SFA provides key insights into the causes of inefficiency by identifying the level of technical and allocative inefficiency, allowing managers to establish how they can best reduce waste and increase their level of efficiency in the best interest of their institutions, shareholders and customers.

In addition, a single economic indicator, in the form of efficiency scores, has great potential in its scope and can serve as a consistent industry-wide measurement of managerial performance.

A little heavy for a blog perhaps, but the propeller heads in the business are really excited by this project.

Especially as we can then apply it to certain parts of the business i.e. how effective is the marketing team? Answer… wait and see.

Investors have been taken on an eye-watering, nerve-jangling roller coaster ride with markets rising and falling hither, thither and yon.

It’s been all too much for many investors, who along the way have chosen to disembark while others have stayed the course. Others still have jumped off and back on several times along the way.

For those lucky investors residing in countries with relatively high interest rates (Australia, Brazil etc.) many have simply sat on the side line and taken the reasonable returns offered from cash and some fixed interest products while the calamity in the market played out… though in Brazil’s case the cash rate is undone by the higher rate of inflation).

The problem was it was never clear when the madness had ended… or even if it has, despite the stellar start to 2012.

Unfortunately in the US, UK and many European markets there has been no such save haven, or Plan B as it were.

Arguably this has been partly responsible in creating new opportunities for asset managers.

The fact investors have not been able to sit on the side line in these markets without standing completely still, creeping backward or at best moving forward at barely a glacial pace (some cash savings rates are a miserly 0.25%) means asset managers have been able to coax investors back into the market.

The low cash rate may explain one reason for the seeming explosion of risk adjusted offers hitting the market over the past few years (or at least being heavily promoted now) but also fund managers were forced to react as redemptions saw millions upon millions of fee generating assets walk out of the door.

The volatile swaying of markets has led many investment managers to bring to market, or simply promote existing products with much more gusto, a whole variety of so-called risk adjusted offers.

The downside of this so-called explosion of products is the added layer of new terminology investors need to squeeze into their vernacular.

Products are now referenced as being… durable portfolios, providing risk-adjusted returns, tactical asset allocation, multi-asset, absolute return, fund of ETFs, diversified, low correlation etc.

Does this make life any simpler for investors? This burningpants scribe doesn’t think so.

More jargon (i.e. marketing bumf) means more confusion – and most investors already struggle with just the basics to even begin.

In the UK the Investment Management Association (IMA) thought it would get in on the act this year by removing what appeared to be straight forward sounding funds for something a little more convoluted.

Cautious, Balanced and Active managed funds no longer exist in the IMA’s categorisations, instead we now have Mixed Investment (20-60% shares), Mixed Investment (40-85% shares) and Flexible Investment.

“Oh, and while we’re at it, let’s throw in Mixed Investment (0-35% shares) and Global Equity Income,” one can imagine the IMA remarking.

The industry is often guilty of over-engineering – though in its defence the Government often adds its own layer of mandated confusion.

But in this day and age of low trust, surely uncluttering would be the way forward not the reverse.

It seems almost impossible to remember that just five years ago the market was dominated by giants which looked unshakable: Nokia, Motorola and RIM (Blackberry) who between them claimed 64% of the market and a complete lock on brand value and distribution.

Now they are all but gone, with Apple and Samsung – businesses that weren’t even phone manufacturers – holding better than half of the entire phone market and almost 80% of the smart phone market.

But it’s not just the phone market that is being disrupted. Publishing, retailing, health and education are all in motion and companies like Groupon and Zynga have erupted from nothing to multibillion dollar businesses in seemingly the time that it takes to make a cup of coffee.

And it seems everyone is feeling the heat – one of the rumours that is driving Facebook’s float is that they think their business might have peaked as a new entrant Pintrest (like Facebook but a lot more visual www.pintrest.com) will start to erode their market share.

It’s only a matter of time before financial services gets swept up in these changes, in fact it is already – oddly in countries like Mexico, Spain and Africa rather than America, Europe and Asia – and its needs to learn how to cope.

While Australia’s banks and super funds can resist change as much as they like, their customers are starting to embrace it with surprising speed, which means they are going to be forced to adapt and probably adapt fast.

This isn’t so much of an issue for the banks, which have in a lot of ways already become a virtual presence, but it’s a really, really big deal for super funds.

The first clue in the data that this is an issue for super funds comes from the way that late Baby Boomers, Gen X and Gen Y are behaving around their jobs.

These generations are considerably less likely than early boomers to consider the idea of a career for life, and employment data from around the world is starting to bear this out.

The average job tenure has fallen substantially – from 8.4 years in 1987 to 4.1 years in 2011.

Granted this is US data – but it’s pretty clear what is happening; a whole series of generations see work as not so much a career but a portfolio of careers – their ideas, their skills and their ambitions are completely portable.

Added to that Australia’s average retirement age is falling – not rising as everyone expected. In the past the average age for retirement was in the low 60’s and now it’s fallen to 57.2 years.

What’s curious about this is that fewer and fewer Australians are retiring because they choose to and more and more are doing so because of work restructuring (they were made redundant or dismissed) or because of health reasons. So while the stated age of intended retirement in Australia remains stuck at 65, it’s not actually happening.

This means two things for Australia’s super funds: within the next 15 years, while there will be a lot more people with super, they will be changing employer every four years,– and that means super funds are going to have to work really hard to keep their members and to explain to them why they should stay with them.

The other implication is that it’s probable that their customers are going to move from the accumulation phase of their superannuation cycle to the spending phase quicker than they intended, which means a whole new series of services, products and a vastly different relationship with the fund.

As keen observers of the industry we can see a small number of funds dealing with this looming change and getting ready for it, but for the bulk of Australia’s retirement businesses, as far as management is concerned the future not only looks much the same as today but pretty similar to 1982.