Could cash really be a better investment than equities?

David Crosoer, Executive of Research and Investments at PPS Investments

With the benefit of hindsight, investing in SA cash over the past year (or even three) looks like a relatively sensible decision. At least, that’s the retort many investment professionals are currently facing as they sit in front of their clients. According to MorningStar (a data provider), the average SA balanced fund (which can invest in cash, but typically holds up to 75% in equities) has returned a negative 0.7% per annum after inflation over the past three years, compared to SA cash that has delivered a positive +1.6% per annum real return.

Despite a challenging three years, the average SA balanced fund (which typically receives the bulk of inflows from investors saving for their retirement) has comfortably outpaced SA cash over longer periods, and even kept pace over the past year (thanks to the last quarter where their international exposure helped boost returns) as evidenced in the chart below. Nevertheless, over periods less than 15 years, the average balanced fund has battled to deliver a 5% per annum real return, which under normal conditions we would expect given its underlying equity exposure. 

The underperformance of the average balanced fund over the past decade partly reflects payback from the prior 15-year period where returns were higher than expected; and the subsequent “clawback” through the 2008 market correction and material underperformance of the average balanced fund value-based strategy. 

More recently (especially over the past year), it also reflects disappointing equity market returns, and an improvement in the real returns generated from SA cash as SA inflation has recently fallen comfortably within the 3%-6% target band.  We think that these improved returns from SA cash could persist, and equities could continue to underperform cash in the shorter-term. 

Does this mean you should now just hold cash, and chide your adviser for investing in a SA balanced fund? 

We think not, despite a recent material upward adjustment to our return expectation from SA cash to 2% per annum above inflation (from 0.5% per annum previously) and the possibility that in the shorter term equities could deliver cash-like returns rather than the 4.5% above cash that is expected from this asset class over the longer term. 

Why? Firstly, a real return of 2% per annum from SA cash may be insufficient for your long-term investment objectives. An adviser would probably place an investor in a SA balanced fund because the required return is greater than that which can be achieved by SA cash, even though SA cash might perform better in the short term. 

Secondly, there is no guarantee that SA cash will give 2% after inflation. We now expect this from SA Cash because we believe that the period of abnormally low interest rates globally is finally over, and the South African Reserve Bank (SARB) is unambiguously committed to a policy of positive real interest rates to shift SA inflation expectations towards the mid-point of the 3%-6% range. Both these assumptions, however, could be incorrect. Inflation could surprise on the upside, and the SARB might be less resilient to political meddling than we think. But even if these cash assumptions are correct, we know that circumstances where equities do poorer than cash are temporary and equities remain the most reliable way of generating meaningful real returns.