Lower inflation creates opportunities for retirement funds to earn low risk real returns using cash

Sean Segar, Head of Cash Solutions at Nedgroup Investments.

Inflation is back in the target range for the first time since August 2016. CPI for April came in at a lower than expected 5.3% and the outlook for a stable inflationary environment looks good. This creates an opportunity for retirement funds to increase their cash allocation to achieve meaningful inflation-beating returns and reduce risk in the process.

Sean Segar, Head of Cash Solutions at Nedgroup Investments, says this is a particularly significant and rare opportunity for retirement funds given the current high levels of risk and uncertainty in the markets. 

“The flat yield curve means that cash is presently also a good alternative to bonds as it offers similar yields, without the volatility of returns. With so much happening on the domestic front and internationally, and with rating agencies camping in the country, bonds are vulnerable to capital loses. Many believe for similar yields cash is a safer bet,” he says. 

According to Segar, because retirement funds aim at steady inflation beating returns, the cash allocation is generally used to provide a stable, predictable and consistently positive return, but it is not often used to generate real return. 

“Cash is the ultimate positive return asset class, with no volatility. When it comes to retirement savings, nobody likes surprises. Currently however, given the low and falling inflation rates and relatively high yields, cash in retirement funds can comfortably achieve 3% real return, which means that cash can make a significant contribution to benchmark beating returns in a low risk manner. This is a great opportunity for retirement fund trustees to increase their cash allocation and achieve better risk adjusted real returns in their funds, which are crucial considerations for retirees given the current economic and political climate” he says. 

Quaniet Richards, Head of Institutional at Nedgroup Investments says reducing or eliminating risk in retirement funds has become an almost overriding concern for retirement fund trustees: “With the flat yield curve, low inflation and steady cash yields, it makes absolute sense for a higher cash weighting as this will not compromise retirement fund returns, but will certainly improve the quality of returns.” 

Segar explains that, given current cash yields, increasing the current cash allocation in a retirement fund not only serves as a very valuable tool to lower risk across the fund, but it also contributes to delivering real returns. 

“The more cash in a retirement fund, the lower the overall risk of the fund will be. Furthermore, the liquidity of the cash allocation provides trustees with the flexibility to remain nimble in the current challenging environment and to easily and efficiently deploy the cash to other asset classes as the opportunities arise,” he says. 

The high real cash returns reduce the potential “opportunity cost” of having a large cash allocation rather than being invested in another, higher-risk asset class. With risk being such a concern for trustees, the opportunity cost is less of an issue. “At the moment, a higher allocation to cash gives trustees an opportunity to reassure members that the 3% above inflation return is locked in on the cash portion of the fund provided interest rates remain stable – with the added benefits of retaining liquidity and not exposing members to additional risk. This is bound to be an attractive proposition for jittery retirement fund trustees and members alike,” he says. 

According to Segar, there is a growing number of Regulation 28 compliant money market funds available in the market that are the ideal place for retirement funds to “park” or invest the cash portion of the fund. 

“A money market type unit trust fund is the ideal vehicle for a retirement fund to use as the cash building block in a retirement fund. These highly regulated, and often rated investment vehicles, offer the yields of fixed deposits, full liquidity, convenience, and diversification - and are typically managed by specialists with large benefits of scale,” he says. 

Nedgroup Investments offers the Nedgroup Investments Corporate Money Market Fund, arguably the lowest risk unit trust available in South Africa, as well as the Nedgroup Investments core Income Fund, which is best suited to cash that is more stable and which the investor does not expect to draw over the short-term. Both funds are Regulation 28 compliant.