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For nearly two decades, the rate of interest investors could receive from holding their money in cash was negligible. In the aftermath of the global financial crisis in 2008, central bank governors in the US, EU and UK cut rates to historic lows in an attempt to stimulate their weakened economies. The Bank of England held its base rate below 1 per cent for 13 years.
But, two years ago, policy suddenly changed. A number of economic shocks in close succession — including supply-chain breakdowns amid the Covid pandemic, war in Ukraine and country-specific issues, such as worker shortages in Britain — sent inflation soaring. Central banks had to act to bring it down.
13Number of years the Bank of England base rate was below 1 per cent
At the start of 2022, the UK and the US, followed later in the year by the EU, began a rate-hiking cycle, which pushed their benchmark interest rates above 5 per cent for the first time in 17 years. Suddenly, holding cash — either in savings accounts, short-term government bonds or money market funds, a cash equivalent — enabled investors to achieve returns in the region of 5 per cent, simply for doing nothing.
They began a dash into cash — a move compounded by equity and bond markets as traders adjusted to the new interest rate environment, pushing even more investors away from risk assets.
Fears of a recession in the US and UK then led to a “wait and see” attitude, with investors preferring to sit on high cash balances. In the UK, for example, cash holdings on the Hargreaves Lansdown retail investment platform rose from £10.7bn at the end of 2020 to £15bn two years later, according to the platform’s figures.
“In uncertain times, cash is a buffer and a layer of protection,” says Benjamin Davis, chief executive of Octopus Investments. “Investors do not like uncertainty and volatility and this leads to people not making a decision on investing their money.”
“Anyone who has free cash is, in the first instance, likely to allocate that to cash products as a buffer,” he points out.
But investment professionals have yet to be convinced that cash is as suitable a holding as other asset classes. “We have worked hard on persuading clients to put money in markets, not in cash,” says Dean Proctor, chief executive at investment manager 7IM.
Investing in cash for its yield is unlikely to deliver the same return as other assets, even before the impact of inflation is factored in.
Data from Asset Risk Consultants shows that investors who exit the market the day after a 20 per cent drop in value and remain disinvested for 12 months afterwards fall far behind those who remain invested through the ups and downs. For example, with a portfolio of £1mn invested in December 2003, divesting after the 2008 crash for 12 months would have seen a forfeit of 12.4 per cent compared with those who stayed in the market. Divesting after the 2020 crash would have made the forfeiture 19.1 per cent. And, if clients divested for 12 months after both of those crashes, they would have suffered a 29.2 per cent loss.
Some investors chose to do this. Paul Kearney, managing director, Asset Risk Consultants, says: “Our data shows that, between 2009-10, the number of private wealth portfolios in riskier assets shrank and moved to lower risk strategies.” And those investors that took less risk in 2009 missed out on significant gains, he says — emphasising how important it is for investors to balance the loss of upside against gaining peace of mind.
“If you are not comfortable with the perceived risk in your portfolio, you should always consider reducing risk — but acknowledge that you will clearly lose the potential to make bigger gains,” Kearney advises.
Expectations of the gains that are possible in this new environment also need to be realistic. Fund managers and financial advisers say they have had to contend with investors expecting market returns above 5 per cent.
“It is a big problem,” observes Ben Kumar, head of equity strategy at 7IM. “People are confusing [the investment] returns that they have had with cash rates on offer.”
Kumar uses the example of a balanced fund that had returned 2 per cent over the past four years. “An investor might say ‘I could’ve invested in cash in that time and got 5 per cent,” but cash rates four years ago were negligible.”
These dissatisfactions are likely to fade in the medium-term, however, as the indications are that interest rates have peaked — pushing investors away from cash.
A widely-watched survey of global fund managers by Bank of America this month showed they are at their most bullish in two years, cutting the cash allocation in their portfolios to 4.2 per cent.
In the meantime, a bit less focus on short-term portfolio make-up might prove beneficial for clients. “Wealth management should be boring,” says Kearney. “It is about grinding out returns, year after year.”
