Attracted to the comfort of cash? - May 2020
21 May 2020
There may be better options to consider
As the Covid-19 crisis unfolded, cash was the only asset class that did not fall into negative territory, producing 1.6% over the first quarter of 2020. So, to many investors, it may feel as though money in the bank is the best strategy to provide them with the necessary comfort and to protect their capital in this new surreal world of a global pandemic, economic uncertainty and hardship. Some investors may even be tempted to switch more of their portfolios into cash.
But here’s the problem
Since the start of the year, the South African Reserve Bank has cut the repo rate by a cumulative 275 basis points (bps), including an emergency cut of 100 bps in March and another 50 bps in May, to provide relief to a struggling economy in the midst of strict lockdown regulations. These cuts are, of course, good news for consumers and business owners needing to make debt repayments, as lower interest rates effectively put more money back in their pockets. However, this is at the expense of savers, as the real return on cash has now moved to close to zero.
So while it might feel like cash is king, investors need to keep in mind that they are now only earning a return that is in line with inflation, while equity valuations are undemanding and the yield on other fixed interest assets remains much higher.
Understand the purpose of cash in a portfolio
It’s always a good idea for investors to have an emergency fund at their disposal, particularly in a time of crisis. What they need to consider (with the assistance of their financial adviser) is why they want to hold cash in the bank or a money market fund and then to identify the appropriate level of cash that they are comfortable with. It is also sensible to have some ‘dry powder’ in an investment portfolio, to use when attractive opportunities arise. Importantly, investors need to ensure that they are not hoarding cash, that is earning low interest, for no reason.
If not cash, then what?
Due to the impact of the rate cuts, investors are currently earning a third less on their cash investments compared to the beginning of the year. The silver lining is that yields on longer-dated interest instruments, such as 10-year government bonds, remain at levels significantly higher than at the start of the year. So it makes sense for investors with longer time horizons to rather be exposed to these longer-dated investments.
The graph below shows this clearly. In the case of a 10-year government bond, the difference between the interest you can earn on cash versus a 10-year government bond (also called the yield gap) is currently at the highest it has been since 1987. At the time of writing, investors in the 10-year government bond can earn around 9% annual interest, compared to the roughly 4.1% yield available from cash (as measured by the 3m Jibar).
While long-term investors need to ensure that they have enough exposure to growth assets (such as equities) to achieve inflation-beating returns, individuals may well have strategic reasons to keep a portion of their portfolio in lower risk yielding assets. Whatever the reason, we believe that for the foreseeable future these investors are likely to be better served by investing such an allocation in a multi-asset income fund than a money market fund. Managed income funds are designed to deliver returns in line with or ahead of cash under most conditions and give you access to the full suite of yielding assets, most of which are currently significantly more attractive than cash. As an example, the retail class of the Coronation Strategic Income Fund, which is actively managed across the yielding asset classes, was yielding 7.4% as at end April, well above the return on cash.