Cash as an Asset Class

Recently the FTSE 100 hit a new all-time high. At the same time in the cycle, UK government bond yields remain at, or close to, all-time lows.

This dislocation between the Equity and Fixed Income markets has led to an increasing call from Investment advisors to take some “chips off the table” and increase the percentage of an investment portfolio held in cash. I was recently presented with a “Balanced Portfolio” where the suggestion was that 8% of the portfolio should be allocated to cash and for a defensive portfolio this can be as high as 20%. These percentages have crept up over the last few months as the valuations of other asset classes have increased.

This is only half the story

In addition to the percentage of cash in a recommended portfolio, it is critical to understand that the wealth manager may only be seeing part of the story. Many clients treat their cash separately from their investments which, except for day-to-day spending doesn’t help anyone. How can the wealth manager give proper objective advice without seeing the full picture of a client’s finances? In most cases, the clients will then sit on the cash in a high street bank earning little or no interest.

When these paradigms are combined, individuals might have as much as half their savings in cash and it is highly likely that this is underperforming.

Step one is for clients is to share the full picture of their finances with their advisor but step two is that, for this to happen, the industry needs to get much better at offering cash investment alternatives.

What does “allocated to cash” currently mean?

Very few wealth managers offer cash investment products and where they do, they are often structured notes where the principal may be protected but any return is actually exposed to interest rates or currencies. These investments require a level of sophistication that is inappropriate for the majority of investors.

For lack of a better option, the wealth management industry often confuses cash and short dated bonds. Not only do they behave in very different ways but right now, the 2 year UK Government bond yields 0.09% while the best 2 year bank account yields 1.76%. The bond is more liquid but for that compromise, the client is earning nearly 20 times the return.

In addition to this, if the amount per bank is £85,000 then the bank deposit is FSCS protected and the risk profile is very similar.

Active Cash Management

The psychology needs to change. All parties should see cash as part of the portfolio rather than a separate afterthought. Cash returns need to stop dragging down the overall portfolio returns and better cash alternatives will give the wealth manager the confidence to give advice to sell and recommend cash as an asset class with less concern for “missing out”. The concept of Active Cash Management is important at any stage in the cycle but arguably even more critical in the current interest rate environment.
How?

While the current interest rate environment is rapidly evolving from helping to damaging the economy, there are three reasons to be optimistic:

* Regulatory change

* Challenger banks

* Technology

A combination of these factors makes the UK savings market more interesting and competitive than it has been for many years. Clients can choose from a greater range of savings products and also move money faster and more cheaply than before.

Is it worth it?

If both clients and wealth managers do more to demand and provide better cash management products then the national impact could be very material. There is more than £1.5 trillion of inert cash in the United Kingdom. If the country can improve the returns on that cash by 1% then that releases £15 billion of improved returns back to investors and ultimately back into the UK economy.