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A forgotten asset class: A case for cash

Shares, bonds, and alternative asset classes tend to dominate media attention and headlines, but there's a forgotten asset class that underpins most investors’ portfolios: cash. Low interest rates around the world have seen cash fall out of favour with investors in recent years. Tony Togher, Head of Short Term Investments and Global Credit, explains some of the different investments that fall under the category of 'cash', some of the risks to be aware of and, finally, outlines the investment case for cash.

There’s more than one way to invest in cash

‘Cash’ funds managed by professional investment managers like First Sentier Investors provide an alternative to term deposit products that are typically offered by major banks. Blending various short-term, money market instruments into low-risk portfolios can deliver steady income with the flexibility of daily liquidity. Unlike most term deposits, investments in cash funds can be withdrawn at any time without surrendering accrued interest.

Over the last two decades, a large number of variant investments have been used in the management of cash portfolios. Most Australian cash portfolios compare or benchmark themselves against the return generated from the RBA Cash Rate, or alternatively the Bloomberg 90 Day Bank Bill index. Using a tried and tested investment approach, our cash portfolios have delivered returns over and above these reference indices over the long term.

Cash portfolios that benchmark their exposures against the RBA Cash Rate usually maintain higher allocations to overnight deposits with banks. To enhance returns, they may also include other highly liquid investments (securities that can be sold on the open market on a same day basis).

Cash portfolios that benchmark their exposures against the Bloomberg 90 Day Bank Bill Index also hold these types of investments. Additionally, they tend to have some exposure to income-style investments with low volatility and favourable ratings from independent credit rating agencies like Moody’s and S&P.

Investments that might be used in the management of either portfolio type include:

  • Overnight Deposits;
  • Term Deposits (TDs);
  • Bank Bills;
  • Negotiable Certificates of Deposit (NCDs);
  • Government Treasury Notes;
  • Semi-Government Promissory Notes;
  • Corporate and Asset Backed Promissory Notes;
  • Floating Rate Notes; and
  • Floating Rate Securities.

With changes to bank funding prudential regulations in recent years, various other investment types have emerged such as:

  • Advance Notice Accounts (requiring notice of intention to redeem); and
  • Convertible Term Deposits (which convert to liquid NCDs upon notice, or at interim maturity of a rolling deposit).

Cash funds may make opportunistic use of these securities, if they can improve the risk/return profile of the overall portfolio without materially affecting overall liquidity or capital security.

The risks

They say there’s no free lunch, and that’s right. In investment markets, it isn’t possible to increase potential returns without accepting a commensurate increase in risk. That said, it is possible to minimise risk in cash funds through a comprehensive analysis of all holdings and by applying rigorous risk management techniques in the portfolio. The various types of ‘cash’ instruments outlined above carry different levels of traditional investment risk. The primary ones are as follows:

  • Duration risk – the risk of interest rates changing following the initial investment. The longer the term profile, the larger the potential risk.
  • Credit risk – the risk associated with the counterparty with which the investment has been undertaken.
  • Liquidity risk – the risk of being unable to sell / redeem or reduce the exposure of the investment, if desired.
  • Return Risk – the risk that both nominal yields and margins associated with various securities may change over time.

These risks are inherent in all debt instruments, though can be mitigated with diligent and active management. With more than three decades managing cash portfolios, we have the experience and expertise to manage exposures through active duration management, portfolio diversification and ongoing monitoring.

As mentioned previously, regardless of the investment – in cash products or other asset classes – investors should expect to receive an enhanced return profile when exposing themselves to a longer investment horizon and to counterparties with credit risk. These risks should not necessarily be considered detrimental – the important thing to bear in mind is that the level of expected return adequately compensates the investor for the risks. In relation to cash portfolios, these risks need to be constantly monitored with allowance made for known – and, potentially unknown – cash flow requirements. This can help ensure that adequate funds are available to meet these requirements and that no penalties are incurred that would detract from the expected return profile.

The case for cash is a personal one

The structural decision to own cash largely depends on an investor’s time horizon and liquidity requirements. For example, clients with specific near-term projects planned, or other known cash flow requirements might maintain higher cash levels than superannuation funds with a young member base, or other institutional clients whose liabilities are longer term in nature.

Cyclically, the case for cash – as always – largely depends on one’s views of other asset classes. The investment profile of cash is unlikely to change significantly in the foreseeable future, so allocations will primarily reflect expected returns elsewhere. In this sense, the use of cash essentially reflects investors’ short-term risk appetite. With this in mind, many investors ‘park’ assets in cash funds during periods of expected volatility in other asset classes.

Australian monetary policy, as represented by the RBA Cash Rate, has been eased recently, with consecutive 0.25 percentage point reductions in June and July.  Current market expectations for future movements suggest the official cash rate could be lowered further still in the months ahead. There is currently around an 80% probability of at least one more 0.25 percentage point rate cut before the end of 2019. Cash funds won’t shoot any lights out from a performance perspective, but their very low risk profile provides ‘sleep at night’ comfort, particularly during periods of market uncertainty when capital preservation considerations are often paramount.

Generally, investors able to accurately forecast their cash flow requirements can allocate strategically to higher yielding, income style investment options. If cash flows are unlikely to impact an investment portfolio for the foreseeable future, the question becomes one of relative value for various investment options going forward. Investors’ investment horizon is also critical, as it will determine the likelihood of other investment types delivering superior levels of return.


Important Information

This material has been prepared and issued by First Sentier Investors (Australia) IM Ltd (ABN 89 114 194 311, AFSL 289017) (Author). The Author forms part of First Sentier Investors, a global asset management business. First Sentier Investors is ultimately owned by Mitsubishi UFJ Financial Group, Inc (MUFG), a global financial group. A copy of the Financial Services Guide for the Author is available from First Sentier Investors on its website.

This material contains general information only. It is not intended to provide you with financial product advice and does not take into account your objectives, financial situation or needs. Before making an investment decision you should consider, with a financial advisor, whether this information is appropriate in light of your investment needs, objectives and financial situation. Any opinions expressed in this material are the opinions of the Author only and are subject to change without notice. Such opinions are not a recommendation to hold, purchase or sell a particular financial product and may not include all of the information needed to make an investment decision in relation to such a financial product.

To the extent permitted by law, no liability is accepted by MUFG, the Author nor their affiliates for any loss or damage as a result of any reliance on this material. This material contains, or is based upon, information that the Author believes to be accurate and reliable, however neither the Author, MUFG, nor their respective affiliates offer any warranty that it contains no factual errors. No part of this material may be reproduced or transmitted in any form or by any means without the prior written consent of the Author.