Investors should think twice before dashing for to cash
South Africans have been piling into cash in unprecedented numbers in the first half of 2008, while pulling their investments out of all other types of unit trusts. Peter Brooke, head of Macro Strategy Investments at Old Mutual Investment Group (SA) (OMIGSA), cautions against this “dash to cash” for most investors. “Although cash can be a satisfactory short-term solution for some, it is not an optimal solution for most investors due to the accompanying inflation, tax drag and self-discipline risks it poses,” he warned at a presentation in Johannesburg on Tuesday.
Record inflows into cash investments – fleeing the bear
With most asset classes - including the “safe haven” option of bonds - posting very poor or negative returns in the first six months of 2008, South Africans have followed many other investors around the world into cash. The Association of Collective Investments (ACI) reported record net inflows of R10.2bn into money market unit trusts in the second quarter of the year, for a total of R19.2bn year-to-date. At the same time, there have been net outflows of around R5.4bn from all other unit trust categories so far this year.
“As of 9 July the US ‘officially’ entered a bear market - equities have now lost more than 20% since their peak,” observes Brooke. “Understandably, fear has taken over and investors worldwide are fleeing the bear. This is a familiar pattern. Yet very few investors, if any, will have experienced the full 20% loss, as they haven’t invested in the exact peak-to-trough period. Most people invest via their pension funds on a regular monthly basis over long periods, so losses are mitigated.”
Brooke says one should be aware that many fund managers (whose mandates permit) have also been shifting towards cash exposure in the funds they manage to mitigate risk and take advantage of the high yields now on offer. Therefore, investors are likely to have already experienced a switch towards cash in their existing investments.
“In our multi-asset class funds, we have been overweight cash for more than a year now, and do see it as an attractive option on a risk-adjusted basis, especially against bonds,” he notes. “As a result, our cash holdings are at record levels in our funds.”
This is important for two reasons, says Brooke. First, the funds are being managed by experts who are looking for opportunities to re-invest, so retail investors are not forced to time the market themselves. Secondly, with many more fund managers adopting this more defensive positioning in their funds – lighter in equities and heavier in cash – many investors are likely to be receiving a higher proportion of their return as a distribution, with less retained for capital growth.
“If savers do not need the immediate income, it is crucial that they re-invest their distributions for longer-term capital growth,” he advises.
The problems with cash
Related to this, he points to three fundamental problems with cash: Zero potential for capital growth, self-discipline and tax drag. First, because cash doesn’t offer any capital growth, it doesn’t provide the real growth required for retirement. Over the past 100 years cash has produced a real return of only 0.8% per year.
Second, as South Africans are well-known for their inability to save, the risk is high that all interest coming from a cash investment will be re-directed towards spending, rather than re-invested. “This danger is particularly high now that consumers are facing a squeeze on their incomes through higher debt servicing, food and fuel costs.”
Tax drag is also a worry. Despite the exemptions offered by Treasury, the higher inflation rises, the worse the tax burden from interest-based investments like cash becomes, reducing one’s real returns. For example, the accompanying chart shows that if you receive a real return of 2% in a high-inflation environment, your after-tax real return is significantly lower (at -1.6%) than that in a low inflation environment (at -0.1%).
Higher inflation increases your tax burden, reducing your real return
“This is why it is imperative for the Reserve Bank to keep inflation under control,” observes Brooke. “There have been times when the Bank was unable to keep inflation below the prevailing interest rates - for instance between 1970 and 1990, when real returns from cash were -1.5%. So you can’t always depend on cash to protect against inflation. Also, it does always present a re-investment risk.” Buying high and selling low: Insanity “This is why it is imperative for the Reserve Bank to keep inflation under control,” observes Brooke. “There have been times when the Bank was unable to keep inflation below the prevailing interest rates - for instance between 1970 and 1990, when real returns from cash were -1.5%. So you can’t always depend on cash to protect against inflation. Also, it does always present a re-investment risk.” Buying high and selling low: Insanity
As for the current retail investor stampede out of non-cash unit trusts, Brooke comments: “People continue to follow the winners. All of this buying high and selling low is absolute insanity. Resource fund have experienced R1.1bn in inflows in the first half of the year (while prices are high), financials have seen outflows of R0.5bn (while prices are low), and property has experienced the largest outflows on record – yields are now at highs not seen for many years. This type of ‘late momentum’ investing will not generate sustainable returns, and highlights the risk of retail investors trying to time the market. History shows this approach does not work – investors should leave it to their fund managers to determine the appropriate timing for investments.”
As for the current retail investor stampede out of non-cash unit trusts, Brooke comments: “People continue to follow the winners. All of this buying high and selling low is absolute insanity. Resource fund have experienced R1.1bn in inflows in the first half of the year (while prices are high), financials have seen outflows of R0.5bn (while prices are low), and property has experienced the largest outflows on record – yields are now at highs not seen for many years. This type of ‘late momentum’ investing will not generate sustainable returns, and highlights the risk of retail investors trying to time the market. History shows this approach does not work – investors should leave it to their fund managers to determine the appropriate timing for investments.”
“This is why it is imperative for the Reserve Bank to keep inflation under control,” observes Brooke. “There have been times when the Bank was unable to keep inflation below the prevailing interest rates - for instance between 1970 and 1990, when real returns from cash were -1.5%. So you can’t always depend on cash to protect against inflation. Also, it does always present a re-investment risk.”
Buying high and selling low: Insanity
As for the current retail investor stampede out of non-cash unit trusts, Brooke comments: “People continue to follow the winners. All of this buying high and selling low is absolute insanity. Resource fund have experienced R1.1bn in inflows in the first half of the year (while prices are high), financials have seen outflows of R0.5bn (while prices are low), and property has experienced the largest outflows on record – yields are now at highs not seen for many years. This type of ‘late momentum’ investing will not generate sustainable returns, and highlights the risk of retail investors trying to time the market. History shows this approach does not work – investors should leave it to their fund managers to determine the appropriate timing for investments.”
“This is why it is imperative for the Reserve Bank to keep inflation under control,” observes Brooke. “There have been times when the Bank was unable to keep inflation below the prevailing interest rates - for instance between 1970 and 1990, when real returns from cash were -1.5%. So you can’t always depend on cash to protect against inflation. Also, it does always present a re-investment risk.”
Buying high and selling low: Insanity
As for the current retail investor stampede out of non-cash unit trusts, Brooke comments: “People continue to follow the winners. All of this buying high and selling low is absolute insanity. Resource fund have experienced R1.1bn in inflows in the first half of the year (while prices are high), financials have seen outflows of R0.5bn (while prices are low), and property has experienced the largest outflows on record – yields are now at highs not seen for many years. This type of ‘late momentum’ investing will not generate sustainable returns, and highlights the risk of retail investors trying to time the market. History shows this approach does not work – investors should leave it to their fund managers to determine the appropriate timing for investments.”
