In the current environment, many investors are worried about their portfolios. Returns have been low for more than two years, and local risks seem high.
Many are thinking about taking all that risk off the table and moving into cash. To them this just seems like the ‘safest option’.
“Cash seems to be top of mind when people are more pessimistic,” says Francis Marais, senior research and investment analyst at Glacier. “When we experience poor markets we become obsessed and think it’s going to continue forever, and so we look at assets that give us the security that cash does.”
There is no question that cash does have its benefits. Primarily, it is a very good protector of capital. The nominal value of a cash investment never goes down, unlike equities or bonds.
Cash also offers you optionality. In other words, you can use it to buy other assets when the markets turn and opportunities come up. You can also use it to cover unexpected expenses if you run into difficulties.
In a balanced portfolio it has real diversification benefits. It adds to your risk adjusted to returns.
Poor real returns
But, as Marais points out: “There is definitely risk in taking no risk.” Cash might seem risk free, but if you put you entire portfolio into a cash investment you are exposing yourself to one of the most destructive risks of all – inflation.
“Ultimately, cash has poor long-term returns,” says Marais. “If you want to see substantial growth after inflation you need to invest in riskier assets.”
Since the turn of the century, there has only been one year in which cash has outperformed both local bonds and equities. It has however been the worst performer in seven of those 16 years.
According to analysis by Glacier, the average annual real return from cash over this period was just 1.46%, compared to 3.28% from bonds and 9.73% from equities.
On top of this, investors who move their portfolios into cash to avoid the risks and uncertainties in markets have to think about how good they are at getting that timing right. How do you know when is the right time to move into cash, but even more importantly, how will you judge when to move back?
“You can’t sit in cash forever,” Marais points out. “You have to move back to equities to make this strategy effective. But studies have shown that even professional investors are not very good at getting this right.”
What makes this worse is that often these decisions, one way or another, are based more on emotion than rational analysis.
“Humans are not prone to making the best decisions when faced with complexity and uncertainty,” says Melville du Plessis, portfolio manager at Sanlam Investment Management. “Behavioural biases trip us all the time. You have to be active in mitigating these behavioural mistakes.”
If investors are however heavily risk averse and they really can’t stomach the current market conditions, what other options do they have? Even if they appreciate that moving into cash might not be the smartest idea, they still want to do something to de-risk their portfolios.
Marais suggests that multi-asset income funds offer a potential solution. These are unit trusts that have very low risk, but are able to invest in a range of assets that will deliver better returns than cash and therefore protect investors against inflation. Over the last four years, when equity returns have been poor, a number of them have even outperformed the JSE.
“We have a broad range of assets to invest in, including bonds with different durations, listed property, preference shares and foreign currency,” says the portfolio manager of the Investec Diversified Income Fund, Malcolm Charles. “There is a lot of opportunity out there.”
Since these funds also invest in a number of different assets issued by a range of different companies, investors are also not exposed to the risk of just one counterparty, as they would be if they put their money in the bank. If that bank were to fail, they would lose anything, but in a diversified portfolio it would only be a small part of the whole.
“It makes sense to use a diversified fund of high quality counterparties,” Du Plessis says. “We understand them, have analysed them and have a strategy to identify the higher quality assets.”
In addition, like all unit trusts investors can access their money at short notice. This means that investors have better liquidity than they would if they put all of their money in a fixed deposit.
“Making a fixed deposit is like going on a three year blind date,” says Charles. “And if things change, you can’t change your decision. If equities fall 20% and you want to switch your asset allocation, you don’t have 24-hour liquidity to do that. If the currency suddenly weakens, you don’t have protection. If the bond market rallies, you can’t take advantage. You need a diversified portfolio for that.”
Article By Moneyweb