Investors will need to diversify as low interest rates start to bite

Investors will need to diversify as they adapt to lower returns from deposits. Photo / File

Diversification is the name of the game in the wake of the Reserve Bank's half a point cut in the official cash rate, but fund managers said investors would need to take on more risk or accept lower returns as interest rates head south.

With interest rates at record lows and share markets running at record highs, now is not an easy time for investors and fund managers alike.

Reserve Bank Governor Adrian Orr surprised the financial markets on Wednesday by slashing the bank's official cash rate to 1.0 per cent.

"There is a strong message here - he is telling us to take on more risk, he's telling us to invest more," Harbour Asset Management managing director and portfolio manager Andrew Bascand.

"If that message is not getting through, then he's not going to have any impact whatsoever - this is intended to run the economy hot.

"Whether it does or not, they don't know, because their key concern is that there is no inflation."

Bascand said buying dividend yield stocks was not the answer for those facing lower bank term deposit rates.

"You have got to have some growth in the portfolio and don't just go out and buy bonds, because actually they are higher volatility and lower in yield than they were," he said.

"You have been encouraged to shift your money into higher risk. Is that right for you?"

He said people needed to establish their investment objectives and see that match their portfolio to those goals.

"You can no longer expect a 5 per cent yield on a lower risk investment. Those yields are gone now."

Fund managers stressed the need for a diversified portfolio.

"There is no one asset, no small parcel of investments that are suitable in the current environment," he said.

Bascand said the days of people relying on term deposits for income were "probably numbered".

Investors would have to accept a bit more volatility, particularly for those who have more balanced or growth oriented portfolios.

Frances Sweetman, senior analyst at Milford Asset Management, said investors facing lower interest rates on savings at the banks would have to accept lower returns unless they were willing to take on more risk.

"Share markets have been big beneficiaries of falling interest rates," she said.

The demand for the healthy dividends on offer from some of New Zealand's listed companies had driven the market sharply higher.

Sweetman pointed to Contact Energy, whose share price has increased 37 per cent this year to date.

"For those looking to share markets for higher returns, low interest rates will likely see the markets continue to be supported in the near-term.

"However, share markets are much riskier than investing in term deposits. Risks are currently elevated and, in many cases, valuations are high.

"This means we should expect volatility, and we have seen this with the escalation of US/China trade talks impacting markets just in the last few days," she said.

Chris Gaskin, portfolio manager at Devon Funds Management, noted the New Zealand sharemarket, which has risen by 23 per cent this year, currently trades at an average price earnings ratio of 22 - high compared to the historical average in the mid teens.

"When different asset classes are doing different things, you need some balanced exposure," he said.

The investment climate, post the Global Financial Crisis of 2008-9, had been challenging.

"In the modern environment, post GFC, you have really had to deal with some influences that didn't exist before, like quantitative easing in the United States and the rest of the world, and incredibly low interest rates, which has made it challenging," he said.

Post GFC, those with a diversified portfolio would have done ok.

"It's been a good reminder as to why you should have one, because things have manifested themselves differently from the way the have done in the past."