Investors are clinging to cash now that it offers a level of income not seen for more than a decade. But in doing so, they're missing out on much better opportunities, Shaniel Ramjee writes in his article on finews.first.
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On the eve of the pandemic, investors were chasing every tiny increment of additional yield. Wherever they could find it. As they had done for much of the post-global financial crisis decade.
It meant Austria could issue 100-year bonds. Companies could borrow at historically low rates with only the lightest of protections for lenders. And the landscape was littered with corporate zombies – heavily leveraged companies whose earnings barely covered interest costs, even at near-zero interest rates.
Everything changed with the post-pandemic global surge in inflation. Yet now that investors can earn rich rewards from public asset markets – including double-digit yields in parts of the credit and the emerging universe – they’re steering clear, clinging to cash instead. Globally investors are holding $2.6 trillion more in money markets than they did in 2018.
«Yet there’s still a reluctance to draw down holdings of money market instruments and shift the capital»
True, for the first time in more than a decade, that cash is generating an attractive return – some 5.1 percent in the US and 3.8 percent in the eurozone. Given inflation has fallen back substantially, that’s a significant return in real terms on both sides of the Atlantic.
But with central banks signaling that they’ll be cutting rates, money market returns have already started to fall, and are likely to drop further – the market is pricing in three quarter-point interest rate cuts in the US this year, which would take official rates to 4.75 percent.
Yet there’s still a reluctance to draw down holdings of money market instruments and shift capital into higher-yielding assets. In part, it could be that this excessive caution has to do with investors re-calibrating not only their risk appetites but also levels of market risk.
«Even the highest quality ‹safe haven› US Treasury bonds suffered double-digit losses during that year»
For instance, the spike in inflation reminded investors that «risk-free» sovereign debt was anything but. Aggressive rate hikes by central banks led to historic selloffs in bond markets and bouts of extreme volatility. So in 2022, global bonds lost 31 percent, the biggest loss the fixed-income market had suffered since at least 1900.
Even the highest quality «safe haven» US Treasury bonds suffered double-digit losses during that year. For investors, those will be painful memories that won’t fade quickly.
And the inversion of the yield curve – shorter maturity debt yielding more than long-dated bonds – makes cash look more attractive. Investors just aren’t being rewarded for taking on maturity risk.
Even so, there’s potentially plenty on offer from credit and equities. Investors should be looking at assets that offer ample compensation against risks, and a buffer against volatility. Right now, certain high-yield credit and emerging markets offer significant protection against drawdowns. Short-maturity investments avoid some of the risks of policy volatility. Overall breakeven yields – the level that yields need to rise before investors lose money – are among the highest in a decade. And then there’s equity.
Equity market volatility has dropped even though valuations are relatively high – particularly in some sectors – and the effective duration of these assets is long. Equities weathered the monetary policy tightening cycle better than bonds, to the surprise of many, because companies themselves can respond to changes in conditions.
«What investors need is a margin of safety»
Corporate management can overhaul their business models and change their general approach as the economic environment shifts. It is telling that, even as corporate earnings suffered initially from rising inflation, they’ve made a rapid recovery since.
This resilience and the fact that most leading economies look set to skirt recession this year against a backdrop of falling interest rates should underpin equities and therefore investor returns.
If the past couple of years have shown anything, it’s that risk is impossible to avoid. Even money market instruments were shown to be vulnerable during the Lehman Brothers meltdown that triggered the global financial crisis of 2008. What investors need is a margin of safety, a cushion to keep them afloat through the market’s frequent rip tides.
Across most risk preferences, investors would do better diversifying their portfolios across the markets’ capital structure than sitting on cash, thanks to the margin of safety on offer from current yields and spreads. Not only is cash, not king, it could prove to be the joker in the pack.
Shaniel Ramjee joined Pictet Asset Management in 2014 as a Senior Investment Manager in the Multi-Asset London team. He holds an MSc in Finance from the University of St. Andres and a BA Hons in Economics and International Business from the University of North Carolina at Chapel Hill (US). He is a Chartered Financial Analyst (CFA) charterholder and holds the Investment Management Certificate (IMC).
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