The value of cash
Ian Scott, Head of Fixed Income at PSG Asset Management.
The value of holding a significant cash amount in a unit trust portfolio is often questioned by various investors. However, cash is an integral part of a robust risk management process in portfolio construction, says Ian Scott, Head of Fixed Income at PSG Asset Management.
“Cash is the asset class that we revert to when we find less or no value in other asset classes at that time. We will happily sit in cash until opportunities arise in markets when quality goes on sale, says Scott.
A good example of this was when the firm’s funds held no government bonds for some years before the latter part of 2015, when government bonds “went on sale” due to the unexpected changes in finance ministers.
“When markets become more uncertain and quality is sold at below average prices, that is when we find the best opportunities to deploy cash. Holding cash in these situations becomes a powerful tool which can be used to acquire bargains,” says Scott.
The one drawback of cash in the period from 2011 to 2014 was that short rates were so low that cash instrument yields were below inflation; in other words, the real yields (after inflation) were negative. Due to the more pro-growth stance of the South African Reserve Bank Monetary Policy Committee (MPC) in that time period, the repo rate was lowered to 5%, while headline consumer price inflation (CPI) averaged around 6%. During that time, holding high cash balances in portfolios yielded returns below inflation, making the decision to sit in cash for an extended period of time unattractive.
“We have witnessed a change in the stance of the current MPC, where the focus has shifted from a largely pro-growth stance, to a more nuanced approach of balancing inflation targeting and economic growth,” Scott says.
The current MPC has clearly stated that inflation expectations must be anchored and that South Africa must maintain a higher real policy rate to maintain currency and inflation stability. This resulted in the MPC increasing the repo rate by 200 basis points in two and a half years, a protracted hiking cycle in SA terms. This has sent an important message to the market that the MPC remains committed to its inflation targeting mandate, notwithstanding the fact that economic growth in SA is low.
What this means for investors
Cash instruments are now yielding above the long-term average inflation rate. Holding cash is beneficial against the negative effects of inflation. Investors do not have to take massive term interest rate risks to achieve high real yields in holding these instruments as they are short- to medium-term in nature. Banks are willing to pay high real yields on these instruments to borrow money from investors. “We believe it is a good opportunity when we find high real yields at low risk.”
Scott says PSG has allocated cash to longer dated bank NCD’s* as they remain attractive on a real yield basis given the level of risk and the expected path of inflation and interest rates. SA government bonds also remain an attractive asset class, due to the high real yield being offered as well as the low credit risk and high liquidity of these instruments. The outlook for economic growth remains low coupled with a temporarily elevated inflation.
“This is not a backdrop that is negative for fixed income. Global macro-factors support the “search for yield” argument and we have witnessed large foreign inflows into SA bonds. We are adding to the bond position on specific points of the nominal curve where the real yield has become more attractive given the duration risk.”
In conclusion, Scott says PSG remains positive on valuation in specific areas of the credit market and will continue to search for real yields that are attractive at the appropriate level of risk.
*Negotiable Certificates of Deposit
