2009: Cash dethroned

Private investors are very poor at timing the 'move' from one asset allocation strategy to another. It is vital to realise that cash is currently the most unattractive asset class on a short-term view.

"Cash is trash!" This of-used phrase echoes through fund managers' corridors whenever we near the bottom of the interest rate cycle. In the US, Japan and the UK investors were shouting the news 12 months ago. In South Africa the cry gathered volume around the second half of 2009 when interest rates hit 11%. Since then we've had another 50 basis point cut with the result cash is the most unattractive asset class on a short-term view.

Local and international empirical research suggests 90% of total fund returns can be attributed to the asset allocation function. Under current market conditions investors should be avoiding cash, but they're not. According to Peter Brooke, boutique head: macro strategy investments at Old Mutual Investment Group SA (Omigsa) fixed income products have attracted far too much capital in the year to June 2009. "The fact that more than 90% of flow has been into fixed income in the last year is cause for concern!" he said. Private investors are very poor at timing the 'move' from one asset allocation strategy to another and thousands of local investors moved out of equities and into cash or cash equivalent products through the 2008 financial crisis.

'Flight to safety'

The so-called 'flight to safety' is evidence of local investors' reluctance to stick with their long-term savings plans.

By moving out of equities and into cash they destroy an asset allocation model that was carefully created to accommodate individual risk and return requirements. The reverse is true at the end of a bull market rally. Since 2003 investor sentiment resulted in equity heavy asset allocation models. The average 60% in equities in January 2003 would typically have reached 85% to 90% by mid-2008. Far too many investors were equity heavy when the equity markets crashed!

This see-saw re-weighting of portfolios indicates a lack of knowledge among private investors. A focus on risk or return means nothing if the entire portfolio is not weighted correctly across bonds, cash, equities and properties. This is the reason asset allocation funds have attracted so much capital in recent times.

Why "cash is trash"

And these funds are avoiding cash like the plague. Under Reserve Bank governor Tito Mboweni (and his predecessor) real cash yields were pegged in excess of 5% for almost 15 years. This 'cash holiday' reversed in the second quarter of 2009. The after-tax yield on cash is now negative and likely to remain so for quite some time.

It took a global economic crisis to destroy cash returns. Governments were limited in their response to the economic crisis. They could intervene through monetary policy decisions – the most popular being interest rate interventions – or fiscal stimulus. The consensus response was to aggressively cut interest rates before reinvigorating the economy with a wave of government expenditure.

One more rate cut

South Africa has cut rates consistently since December 2008. The best we can expect is another half percent this year followed by a long period without further change. 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%. As Brooke comments: "The glory days of cash and bond returns are probably over!.