Holding excess cash is a costly strategy in today’s ultra-low interest rate world. Instead, we see various opportunities to put cash to work and seek yield, while also diversifying portfolio risks.
- In past times of market turmoil, it was often said that “cash is king”
- Cash served not only to dampen portfolio volatility, but also often acted as a steady source of modestly positive returns
- Cash currently offers no yield, little diversification value, and is likely to be the largest drag on portfolio returns
- In this environment, we want to focus upon opportunities for generating better returns from bonds
Despite today’s ultra-low interest rate environment there are still opportunities for yield.
Let us be honest, in previous downturns it also always “felt good” to see something constant when markets tumbled. Cash served not only to dampen portfolio volatility, but also often acted as a steady source of modestly positive returns.
In every downturn the headlines would surface: 'Cash is king'. We have a variation to this: 'Putting cash to work is now king'.
A key reason cash needs to be put to work is that in response to the COVID-19 pandemic’s financial fallout, the Australian Reserve Bank lowered interest rates to 0.25 per cent. As a result, cash currently offers no yield, little value in the way of diversification, and is likely to be the largest drag on portfolio returns.
Our strategic asset allocation methodology now estimates an annualised return before inflation of just 0.6 per cent for cash over the coming decade. In this environment, we want to focus upon opportunities for generating better returns from bonds, while holding modest cash balances sufficient to cover real expenditures for a reasonable period. Here are several options:
For a brief period in April, US investment-grade (IG) corporate bond yield curves were near their flattest since 2009. However, the bounce-back in global risk assets has driven curves sharply steeper, with short term yields falling. This presents an opportunity to extend duration modestly beyond cash and cash alternatives. For example, yields on US IG corporates maturing in three to five years is near 2 per cent or 50 basis points (bp) more than similar bonds maturing between one and three years. Although adding a small amount of interest rate risk to portfolios, this is the largest yield pick-up on this part of the IG curve in over two years.
Australia's currency is a commodity currency and also a risk currency, meaning it normally depreciates when commodity prices are falling but also when international risk is high. The US dollar is a safe haven currency, meaning it normally appreciates during international crisis, like a global financial crisis or pandemic. Japanese yen is also a major safe haven currency.
This creates opportunity to purchase offshore assets, like US IG bonds, in US dollars and seek a currency benefit to boost your overall return.
Switching and managing currencies is a simple process with a Global Currency Account
You also earn interest while waiting to decide when to trigger your investment.
Another option is structured products (SP's). Also referred to as structured solutions or structured notes, it typically pairs a bond and a share or basket of shares to form an income bearing product with exposure to equity markets.
Structured solutions are gaining interest for three reasons
- Ultra low interest rates have pushed equity markets higher despite considerable risk from global macro events, leaving investors looking for opportunities that offer more stable returns than direct equity investment.
- SP’s can help manage the downside risk of equities.
- SP’s have benefited from technology over the past 10 years as banks utilise advanced modelling to improve the offering.
Structured notes are particularly useful for investors that don't want to take a strong view that equity markets will rise or fall dramatically, as investments can be designed to profit in a number of various market conditions, even if the underlying equities in the structured ‘basket” increase, remain flat or decline up to 40 per cent in many cases.
The clear message is that sitting on cash will not bring benefits to your portfolio. It's a time to be fully invested and make your money work for you.
David is chief investment officer for Citi
Kris is global head of fixed income strategy for Citi
Peter is an investment specialist for Citi Australia's wealth management business.
Wealth Solutions >