The cash return holiday is over
There are two sides to the interest rate debate. Those of us who invest in property and other fixed assets spend so much time complaining about the high cost of capital that we forget the thousands of retirees (and savers) who rely on fixed income investments to get by. What happens to them when interest rates fall? FAnews Online searched for answers at the Old Mutual Investment Group SA (Omigsa) quarterly press conference, held in Johannesburg on 21 July 2009. Peter Brooke, head of Macro Strategy Investments presented a series of slides titled: “The quest for real return.”
Brooke kicked off his presentation with a bit of a history lesson. “We’ve had real cash yields of nearly 5% for the last fifteen years,” said Brooke. Love or hate him, local savers have enjoyed a prosperous time during Tito Mboweni’s rein. In contrast, savers suffered negative real returns on cash – before taxation – in the pre-Mboweni era. The bad news for savers is that South African cash entered a negative real return situation in Q2 2009.
Cash is trash
Plummeting global interest rates underline the “cash is trash” tag. In the last six months 44 of 46 countries monitored by Omigsa have cut interest rates, with 19 of these countries at 2% or less. The G7 countries report average interest rates of just 0.6%. There are serious economic consequences to declining interest rates including low returns on defensive funds, subsidisation of banks by savers and the threat of inflation! Brooke points to the US and UK where savers are getting near zero returns while banks build up their balance sheets. “The very institutions who led us into trouble are now getting bailed out by savers!” said Brooke.
“For the first time in three-and-a-half years both bond yields and property yields are returning in excess of cash,” said Brooke. This yield gap between bonds and cash is mirrored all around the world. “It’s a no-brainer to get out of cash overseas!” said Brooke. And in South Africa, negative cash yields will result in a return to risk appetite too. “As soon as cash return goes, you see a return to risk appetitive – in other words markets recover, volatility falls etc.” Investors will undoubtedly do better in property, equity and cash in the short term.
What will happen going forward? “Betting that the world will not have a recovery is a mistake,” said Brooke, adding that most developed economies would make steady progress in 2010. Under this scenario equities will quickly gain favour. “In South Africa we would expect inflation to come down,” said Brooke. But he warned that the Reserve Bank was extremely concerned with how sticky inflation has been on the way down. “Guessing where interest rates are going to be is a bit of a lottery over the next year,” said Brooke, adding that we won’t witness a return to 5% real returns in cash any time soon.
Asset allocation ideas
This is great for news for creditors (people who have borrowed large chunks of money), but not good for savers. What should savers do to secure real returns when the cash yield plummets? “Going forward they need to buy equity,” said Brooke. He believes there will be significant movement of funds out of cash investments back into equities, properties and even bonds as fund managers digest the two undeniable truths. First, that earning a real return from cash in the next few years is near impossible, and second that billions of rand of investors’ capital is currently languishing in cash or near-cash product.
Brooke praised local fund managers for topping up on equities through the recent market correction. He notes that equity exposure among South Africa’s institutional investors went up across the board as the big asset managers bought equities through the dip. “Assets were cheap and they went in to get the money,” said Brooke. Unfortunately the man in the street hasn’t followed suit. Over the same period assets under management in the Old Mutual Money Market Fund topped R10bn. And at the time of the presentation more than half of unit trust assets were in fixed income.
The Omigsa view for real returns on domestic asset classes in the next 12 months is: equities +7%, property +6%, bonds +3% and cash 2%. Although Brooke warned investors of potentially disappointing earnings from equities in the next six to nine months he believes equities are fair value and will provide a real return going forward. Brooke expects international returns on equities +8%, bonds +2% and cash 0%. There’s no argument for holding cash internationally. There – like here – investors will choose equities, underpinning prices as they move the huge loads of cash currently parked in ‘money market’ investments.
Editor’s thoughts:
With real returns on cash already negative any further cuts by the Reserve Bank will cause serious damage to South Africa’s savers. Individuals saving for retirement are clearly not going to bank the inflation plus 5% they’ve become accustomed to in previous years. Would you reassess your client’s asset allocation under current conditions? Add your comments below, or send them to [email protected]
