By Thomas Strickland, Associate, Structured Products
It has been nearly a decade since the onset of the credit crisis, when the thought of putting cash under the mattress seemed to be a rational decision. As the world descended into financial crisis in 2008 there was no shortage of depositors and investors who had their fingers burned.
Today, concerns around holding cash are less about safety and security, and more focused on the risk its real value erodes over time. Interest rates in the developed world are at such low levels that many people are questioning the value of a short-term deposit strategy, given it exposes cash to the risk of losing purchasing power as inflationary pressures bite.
The chart above shows how cash has lost value in real terms over the past 10 years. If £10,000 was invested at the Bank of England base rate on 1 January 2007, its value would have risen to £11,499 in nominal terms by 1 January 2017. But the effects of inflation will have reduced its purchasing power to just £9,090 in today’s money over the same period.
This trend looks set to continue for the foreseeable future as market indicators currently suggest inflation will remain elevated and interest rates will stay lower for longer. For many investors, the alternative to holding deposits in the current climate is to put it to work in equity markets. But doing so comes with its own set of risks.
A direct outcome of the era of monetary easing witnessed since the financial crisis is a prolonged stock market bull run that shows little sign of abating. Many investors have made attractive investment returns; however, not everyone has the appetite for equity risk no matter the circumstances.
With that in mind, what options do you have if you want to look beyond equity investments?
Alternative strategies for cash
Investors have several options at their disposal for investing their cash. For those who require access at the press of a button, the bank deposit account remains the clear winner even if it erodes purchasing power.
For those who do not need immediate access and are willing to adopt a longer-term strategy, there is the potential for earning an enhanced yield through one or more different cash management solutions.
Potential solutions might include:
- An increased investment term – exploring a longer time horizon for at least a portion of the cash, the portion for tomorrow not today.
- Corporate bonds – headline yields to maturity have suffered in the low interest rate environment. But an active manager can source opportunities to diversify and enhance returns in a variety of ways.
- Foreign exchange strategies – currency markets are highly active and interest rate differentials both now and in the future can have an impact not only on currency movements but also the returns available from investments in a particular currency.
- Esoteric solutions – such as structured products and actively managed funds – can take advantage of the liquidity premium available to enhance returns.
There is also the option of considering a smart integrated solution using the above tools. This could not only add a much needed boost to returns, but also develop a strategy designed to withstand changing market conditions over time.
Interest rates to remain low
We know that holding cash on deposit has done little to preserve wealth in real terms for much of the past decade. For the reasons already mentioned, this theme is likely to continue for the foreseeable future.
More recently, economic conditions in many developed markets have shown improvement. The problem for savers is that the process of returning interest rates to normal levels will be slow and gradual.
In the U.S., the Federal Reserve has begun gradually raising interest rates. But in the UK, the upcoming Brexit negotiations and a weaker economic outlook could see interest rates stay lower for longer. The eurozone, meanwhile, has seen actual negative interest rates for some time and, while economic conditions have improved, the next upward move in interest rates is not yet on the agenda.
Inflation continues to outpace income on cash, so whatever the optimal solution may be, the starting point is to consider liquidity needs, opportunity cost, risk appetite and the potential for capital value erosion.
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