In order to reflate their economies, policymakers and central bankers have pursued a path of depressing interest rates and injecting unprecedented amounts of liquidity into the financial system.
So not only are savers being punished by the lack of interest available on cash deposits in the bank, but because of monetary-stimulus measures such as quantitative easing (QE), the general consensus is that inflation is the only outcome, eroding the value of savings even more.
Performance of cash vs inflation over 5yrs
Source: FE Analytics
On top of that, fixed income securities – which have traditionally been the more cautious investor’s first port of call – are not looking as safe as they did in the past.
Ten-year gilt yields have already risen from nearly 1.6 per cent to 3 per cent in roughly 18 months, which means that bond investors have incurred hefty capital losses over that time, but market commentators say this is just the beginning of a longer term trend.
Because of the reasons mentioned above, private investors are seemingly being pushed into higher risk assets – namely equities.
Although the overall backdrop for equities seems supportive, fears over the tapering of QE in the US, the economic slowdown in China and the continuing sovereign debt crisis in Europe all still represent headwinds for investors.
Paul Warner, managing director at Minerva Fund Management and an AFI panellist, says that because of the huge amount of intervention and price manipulation on the part of central banks, he is keeping a high cash weighting in his personal portfolio.
Warner explains that the amount of cash an investor should hold depends on their time horizon. He says that anyone who is not going to touch their money for a long time should probably use equities, but investors who only have a short horizon should not be afraid to use cash.
He adds that although investors are not going to make any money from cash, it is one form of investing where you cannot get your fingers burnt.
"In my own portfolio – my SIPP – I have around 40 per cent in cash. But I hate the returns I am getting from cash. Whether it is the best strategy, I don’t know," Warner said.
"When I am running portfolios for other people, I assume they are giving me that money to invest. The reason I have a lot of cash in my own SIPP is because I don’t know how fears over inflation will play out."
Warner says that his thoughts about holding cash in an anticipated inflationary environment may seem slightly counter-intuitive, but that it is better than investing for the sake of it, as the future of financial markets is a mystery.
"Everyone seems to be following the same theme, which is reflation," he explained.
"Carney, Osborne and nearly all the world's central bankers seem set on bringing about inflation. Even in the US, even though they are planning to taper QE, they are only reducing stimulus – not stopping it all together."
"When everyone is singing from the same hymn sheet, it does look inevitable. However, it could quite possibly be that inflation doesn’t come through for another two or three years."
"If there were to be a major setback in financial markets before then, what is the difference between losing a bit of cash value through inflation and then buying into the market at much lower levels than you could before?"
"Are we going to see another major setback in the market? I don’t know. One thing that is for sure is that we are watching one of the largest financial experiments and no-one quite knows how it will play out," he added.
Another option for cautious investors to protect the value of their capital is via absolute return funds, which aim to make money – albeit not enormous amounts – in all market conditions. This weekend, FE Trustnet’s Thomas McMahon will look at the best way to judge the performance – and ultimately choose – the best targeted absolute return fund for your needs.
However Mike Deverell (pictured), AFI panellist and investment manager at Equilibrium Asset Management, fully appreciates why investors need to hold cash instead of putting money into a fund for the short-term.
"I think when you are talking about cash, you have to define what it is for," he explained. "From a financial planning point of view, we always say that investors should have a certain amount saved as emergency funds."
"However, if they are saving that cash to make returns, that is where you have to think about what you can do. With interest rates at such lows and if you are happy to put that money to one side, then you might as well invest it," he added.
Deverell says that instead of upping their risk exposure because of the low returns on cash, investors should allocate "tactical cash" to offset the current environment of ultra-low interest rates.
"We only do it if our clients are happy to do so. But, if for instance equities have just sold off, then we would use that tactical cash to buy into the market at low levels and sell when the market rebounds, assuming it does of course."
