With a great deal of geopolitical uncertainty and some market headwinds still unresolved, it might be tempting for some investors to take some risk off the table and hold cash instead.
Aberdeen Standard Investments’ Gerry Fowler said 2019 was a more positive year for markets than initially anticipated with the Q4 rally coming after months of macropolitical uncertainty that created a drag on markets.
But there are still potential issues in the year ahead.
Looking at developed market bonds, Fowler said it’s hard to find any that give a yield above 2 per cent. Meanwhile, equity valuations are “as high as they’ve ever been since the 2000 bubble”.
“After a dramatic slowdown in global growth in 2019, we don’t hold out much hope that stronger growth will save the day.
“Perhaps it’s no surprise then, that investors are worried about their money this year and have been piling into money market funds,” he added, noting recent investor surveys by Bank of America Merrill Lynch showing increased cash holdings.
Inflows into money market funds from 1990 to now
Source: Bloomberg
Nevertheless, the multi-asset strategist noted that over the past 40 years “there have been only five calendar years when holding cash has been better than investing in either bonds or equities”, for US investors at least.
And 2019 was not a year where it was better for investors to hold cash, said the multi-asset strategist – given the “robust” performance from equities and bonds.
Whilst cash definitely has a role in investors’ portfolios, Fowler said that there are four reasons why they might actually be making a mistake by piling into cash now.
Real interest rates are negative
Interest rates were a major story in 2019, with the US Federal Reserve reversing its programme of policy tightening and interest rate hikes amid investor growing anxiety. The Fed made three rate cuts during the course of last year but wasn’t the only institution to act.
However, positive real interest rates have been important for holders of cash in each of the five years when they beat bonds and equities.
“In 2019, global central banks collectively made 80 interest rate cuts and pumped over $400bn into the world’s financial system reducing cash returns to negligible, sub-inflation levels across developed markets,” Fowler said.
“With such an abundance of cheap money sloshing around, we don’t expect real interest rates to be positive in any major economy in 2020.”
Indicating that the conditions are not right for cash to beat out bonds and equities again.
There’s always a good investment somewhere
Fowler said his historical analysis of cash versus bonds and equities only relates to US assets, suggesting that investors might be able to put their cash to good use elsewhere around the world rather than sitting in the bank earning only low levels of income.
“For example, emerging market bonds currently provide a yield of around 5 per cent,” he said. “Yields on comparable developed market government bonds are much lower: under 2 per cent in the US, around 0.5 per cent in the UK and negative in many European countries.”
“Emerging market debt is one of several strategies we like that potentially offers an attractive trade-off between risk and return.”
If nothing’s going up, go short
For investors that are worried that assets are about to lose value, there is a simple solution: go short.
Just as it’s now easier for investors to access different markets they can also access alternative investment processes “able to deliver positive returns irrespective of whether markets are rising or falling”.
“To achieve this, so-called ‘absolute return’ funds manage investment risks more precisely and use all investment tools and techniques available,” he said.
“This includes taking short positions that make money when an asset price falls.”
However, it is worth noting that absolute returns do still carry a range of risks and are not a guaranteed investment option as their name is sometimes mistaken for.
Put your cash to work
While holding cash may feel secure, the multi-asset strategist said, “in reality it comes with three insidious effects”.
“It is eroded by inflation, which, despite currently being low, soon adds up,” he said. “There is the opportunity cost of the returns that you might have had, if you had been invested. Most significantly, there is a timing risk when you do decide to put the money to work.”
Fowler concluded: “As others put their cash to work before you, they drive up asset prices, making your decision to invest more risky – there is a cost to being last.
“As we enter a year when real interest rates are negative, cash may soon become a hot potato.”