One of the discussion topics that often comes up with advisers now is the increased nominal returns on cash. Basically, 4% on deposits looks very attractive to low-risk clients given the poor and volatile returns in recent periods on fixed income and many defensive funds. 
The dash to cash
In our view, clients that dash to cash are taking several considerable risks, especially at this moment in time. This is not to says that cash does not have an important role in client portfolios – not least to reduce sequencing risk – but also as a place to hide when markets are difficult. The merits however, come with risks of their own.
Although often regarded as ‘risk free’ this is a superficial way of understanding cash. Most obviously cash is a nominal asset, it yields interest, but that interest may be less than the rate of inflation. This is particularly so at the moment. While the nominal value of a client’s money may be preserved and growing, the spending power of his wealth is declining significantly over time.
If you are going to panic, panic early, not late
Another major issue with cash is more nuanced but also important. Running to cash at the current time may seem a safe move in uncertain times, particularly when deposit rates are high. As mixed asset managers this is one of our preferred strategies for dealing with potential equity market declines.
However, this impulse must be tempered with the understanding that the times when cash seems most attractive are very often the best medium term buying opportunities. If you are going to panic, panic early, not late.
When using cash as an alternative to fixed income you must be aware of what fixed income managers call reinvestment risk. Cash matures every day. One-year bonds mature in a years’ time. If tomorrow’s rates are lower than today, you may have been better off buying a one-year bond.
If in a years’ time rates on one-year bonds are lower than today’s two-year bond – the two-year bonds would have been a better investment. Essentially, going to cash or short-dated bonds comes with degree of risk, you might miss out on locking in much higher returns in the medium term if yields further along the curve fall.
The odds are against you
Basically, owning cash is a view that other assets are going to fall in price for the time being and comes with the risk that inflation will be damaging. This might be right on occasion but in the long run the odds are against you. Equities go up over time and offer dividends. Longer term bonds typically offer higher yields than shorter ones, and corporate bonds come with a credit spread over governments.
The purpose of cash is to fund immediate (perhaps six months or year) spending needs and as a tactical asset in times of uncertainty. We think the first is the role of the adviser and the second is the role of a mixed asset manager.
This is where funds such as the Premier Miton Defensive Multi Asset fund can be a useful tool for advisers. We understand the importance of risk profiling. Some clients will profile as low risk and some others will desire to be lower risk in volatile times. These clients are not the sole audience for defensive funds.
Another common way of looking at a client’s needs is to consider when the client needs the money, not just how much volatility they can tolerate. Post retirement clients often have some near-term spending desires, while most of their needs will be a long term in the future. So near spending needs in cash and low risk funds with the longer-term requirements in higher risk strategies can make a lot of sense.
David Jane is a member of Premier Miton’s macro thematic multi asset team. The views expressed above should not be taken as investment advice.