Tlhoni Komako, Portfolio Manager at Ashburton Investments
For the first time in years, cash (including money market funds and short-term interest-bearing income funds) is offering juicy yields and there is nowhere else to hide. Cash as an asset class has become increasingly attractive due to a combination of factors, namely market volatility, economic uncertainty, and central banks moving from low pandemic interest rates to hiking rates to levels last seen 15 years ago before the Global Financial Crisis (GFC). Before exploring why cash has become more appealing, let’s first look at how we got here.
How did we get here?
The Covid-19 pandemic created significant uncertainty in financial markets. We saw central banks cut rates massively to stimulate economic growth but then they got behind their inflation curves before they started hiking rates. This, coupled with constrained trade in supply chains, has influenced consumer prices and caused inflation to be stubbornly high since 2022. Though we are seeing disinflation now, stubborn inflation is still a concern.
Since then, cash has emerged as a defensive asset class for many investors seeking stable returns, while getting some protection against market volatility and downside risks. Putting this into perspective (Figure 1) over a 12-month period to end-February we have seen cash (SteFI) outperform bonds (ALBI) by 77 basis points (bps), while relative to inflation-linked bonds (CILI) and equities (ALSI Capped SWIX) cash outperformed by 299bps and 195bps respectively.
Figure 1: SA Asset Class Total Returns %
Why has cash not been attractive vs the 60/40 portfolio in the past, and how long is it likely to last?
Historically, cash has not been as attractive relative to equities and bonds because it offers lower returns while equities and bonds have the potential to generate significant returns as well. In addition, holding too much cash for too long can result in missed opportunities for potential returns, and high inflation can erode the purchasing power of cash over time, resulting in low/ negative real returns.
The source of the popularity of the 60/40 portfolio is the traditionally negative correlation between the equity market and the bond market, where 60% is invested in stocks and 40% in bonds. Meaning they assist each other, when equities sell off then bonds usually do well or protect the portfolio. These two asset classes rarely go down at the same time, but this hasn’t been the case recently due to several factors, including rampant inflation.
For the US case, money market funds have seen record-high inflows with total assets now sitting at US$4.9tn. For the first time in over two decades, the yields on six-month US treasury bills are higher than the returns on the classic 60/40 portfolio. Bringing it back to SA, a one-year bank negotiable certificate deposit (NCD) is offered by the big five banks at an average offer rate of 9%; this investment is higher than the three-year R186 bond yield of 8.45% (at the time of writing) with a fraction of the duration risk.
As central banks are approaching their interest rate hiking peaks and markets expect them to pause/hold rate decisions before cutting rates later, this means that cash will continue to offer attractive returns. So, the appeal of cash as an asset class is likely to continue for the foreseeable future, or at least in the medium term as market volatility and economic uncertainty persist.
Conclusion
We can clearly see that cash is not trash; it does serve its purpose, especially during these volatile times.
Investors can expect continued slow economic growth in the near term, continued market volatility, economic uncertainty and rate hikes. JP Morgan is currently forecasting SA headline inflation to be at 5% y/y in December 2023.
Cash liquidity funds have projected effective annual gross yields of around 8.2% to 9.1%, meaning investors can safely earn between 3.2% to 4.1% in real terms while waiting for the dust to settle as central banks finish with their hiking cycles. When interest rate hikes pause, the appeal of cash may decrease, but for now, it remains an attractive option for risk-averse investors looking for a safe haven.
