Why cash is an investor's security blanket

The popularity of cash products does not seem to revolve solely around investment sentiment anymore. Milana Pokrajac reports.

Self-made multimillionaire and financial author Robert G. Allen recently uttered these famous words: “How many millionaires do you know who have become wealthy by investing in savings accounts? I rest my case”.

While Allen makes a valid point, wealth accumulation is still not the top priority for many investors and their financial planners.

The memory of the 2008 plunge and the crisis which ensued is still fresh, while constant mention of another dip does little to encourage investors back into the ever-volatile investment markets.

Thus, priorities still seem to revolve around risk avoidance and protection from capital loss.

Cash – the investment of choice

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In the year to November 2011, there was a substantial shift away from growth assets, according to research from Investment Trends.

Financial planners almost doubled their allocation of new money to cash products over the past year, with an estimated $56 billion having been held in aggregate excess cash (refer to Table 1).

In the survey conducted by Investment Trends, financial advisers indicated that the main reasons for so much money being held in excess cash revolved around the lack of confidence in the stock market and the economic recovery.

This data merely reflects the latest sentiment figures released by Wealth Insights, which show investor and financial planner confidence plunging to one of its lowest points in the second half of 2011.

The lowest was the September quarter, with investor sentiment falling to -81. The three months leading to December 2011 saw the confidence slightly improve, but it still sat at -76.

The figures found in the Wealth Insights Sentiment Index represent a huge dip in confidence, considering investors were highly optimistic in the early months of last year.

The survey came up with similar results to those found in the Investment Trends research, showing a significant move to cash and fixed income – a trend which was evident even in the high-net-worth client space.

In a recent interview, Wealth Insights managing director Vanessa McMahon attributed market aversion to news headlines that focus on Europe’s debt crisis and a possible second GFC.

The popularity of cash comes as no surprise. The Australian share market delivered a loss of 6.27 per cent for the 12-month period ending November 2011 (as measured by the S&P/ASX 300 Accumulation Index), while an average term deposit returns around 6 per cent in the initial year.

But for Kirsty Dullahide, general manager for investment and strategy at Australian Unity, cash domination is a sentiment story – and a very ironic one at that.

“The performance of the Australian stock market does contribute and feed back into the performance of our economy, which then kind of feeds into how people are feeling, and so on,” she said.

“They are certainly linked, and often people’s fear is one of the biggest contributors to how our actual investment market will perform – and that goes for any asset class.”

As a result, many product providers have recorded a spike in the uptake of their cash products over the past 12 months, particularly in term deposits – the appeal of which does not seem to fade.

Around 18 months ago, ING Direct launched a suite of term deposits available only to advised clients. Since the launch, the product has grown to $1.3 billion.

“The majority of this money has gone into long-term cash and also into term deposits,” said Rachna Chandna, head of advice distribution at ING Direct.

Colonial First State’s (CFS) FirstRate Investment Deposit – which was launched last April – has grown $100 million. 

Similarly, ANZ-owned OneAnswer platform introduced six new ANZ term deposits which have generated more than half a billion dollars in inflows in under a year.

Billions of dollars held in excess cash ought to be returned to the market once sentiment improves, but is the domination of cash just a sentiment story or is there more to it? 

Here to stay 

Despite the prolonged period of volatility, the history has shown that the markets will eventually rebound, and it is only a matter of time when equities start offering higher returns than income producing asset classes.

But Chandna believes that cash is no longer just a parking mechanism, but has well and truly become a permanent part of investors' portfolios.

“We know cash won't be king forever, but we've got a lot of financial advisers asking for strategic advice on cash – things like how to build cash into strategy for the long-term,” Chandna said.

The ageing population might play a crucial role in the continuation of this trend, as the first of baby boomers have entered retirement last year, with the rest to leave the workforce in the coming years. Many cannot afford losses or great risks, according to head of cash business at Macquarie Group, Peter Forrest.

That investors are using cash as part of their long-term strategy is particularly evident amongst those who are risk adverse or heading towards retirement, Forrest said.

"In pre-retirement and retirement, it is becoming at the forefront of people’s minds that they will no longer be receiving an income," he said.

"Capital security and providing certainty and control is really important to them, and cash provides that; it allows financial advisers to plan for definite outcomes."

However, these observations are probably part of a bigger trend. Since the GFC, financial advisers have become more sophisticated in how they segment their client’s portfolios, according to Colonial First State’s head of investment research, Peter Chun.

“They generally set up buckets,” Chun said. “There is an income part of the portfolio, but there is also a growth bucket that’s more long-term focused which could eventually fund longevity.”

“You still need a bucket of your portfolio that is looking to achieve growth,” he added. “When someone retires, they could live another 25-30 years, so if they were to park everything to cash or very conservative assets they may run out of money to fund their retirement.”

The so-called ‘bucket strategy’ also makes the conversation between financial advisers and their clients a lot easier, according to Barry Whyatt, the director of sales at AMP.

“If you actually split the components of their portfolio into four different buckets – cash, fixed income, high yield in shares and annuities – clients would see that they’ve got short-term money, medium-term money and longer-term money,” Whyatt said.

“When the market goes down your long-term bucket goes down in value – but you’ve already earmarked that at the initial advice stage as being the long-term bucket which you won’t touch for 7-10 years; so there is no need to panic, since you’d have plenty of money in the short-term bucket, and that’s where term deposits are.”

A tipping point 

While banks and other institutions keep offering very competitive rates on term deposits, the question on everyone’s lips remains: will there be a point where investors will start looking for more value elsewhere and how soon will it come?

Two consecutive rate cuts by the Reserve Bank of Australia (RBA) recently brought the official cash rate to 4.25 per cent (TBA), with a 100 basis point drop to 3.25 per cent forecast by November 2012 (refer to Graph 1).

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For Whyatt, the tipping point will happen once investors stop getting more than 5 per cent interest on their term deposits.

“Although equities don’t have the capital stability or guarantees, the pure income yield now from the stock market is so attractive that there’ll come a point as term deposits drop below 5 per cent (if interest rates continue to fall and if the yield on investments is over 6 per cent) where investors will start thinking about going back to the stock market with some of their money,” he said.

There is no question that if the RBA keeps cutting interest rates, staying in cash will become rather challenging, and financial advisers may start to look at getting back to the market, Whyatt says.

But it may take a while until this happens. AMP Bank has increased both its six-month (now 6 per cent) and 12-month (now 5.5 per cent) term deposit rates, while their competitors keep offering similar rates.

According to Chun, the pendulum is still “on the cash side”, and it might take a while until the money starts flowing to other asset classes.

“For most investors, the returns have been quite challenging – not just in the last 12 months, but in the last five years since the GFC,” Chun said.

“So for most clients (who mostly are either retirees or just retired) it is still very attractive, having cash returns with very little volatility and also a fixed rate.”

No love for CMTs

In 2010, Macquarie transformed its cash management trust (CMT) into a cash management account (CMA) following the approval of its unit holders.

Peter Forrest said there were two reasons for this move.

“A CMA is a bank account, and the Government guarantee applies for a bank account,” he said. “And secondly, retail deposits are able to offer higher rates than can be achieved by a CMT, which invests into wholesale markets.”

The move away from the CMT space was also seen by Phillipa Sheehan, the managing director of My Adviser.

“If clients are wishing to sit in a cash environment, they are really sitting in a CMA term deposit space,” Sheehan said.

In December 2010, AXA made a decision to close its CMA to new business. The company said the decision was made in recognition of a decline in market demand for retail unit trusts.

“New flows into these products are generally sourced from platform-based offers, and there have been very few new direct clients into the fund in the last two years,” AXA stated on its website.

Fixed income a segue into the market?

Term deposits, CMTs and CMAs are all very clean and simple to understand. But when investors finally decide to reinvest excess cash, they will take smaller steps back into the market rather than diving in, according to Kirsty Dullahide from Australian Unity.

Fixed income will be a natural segue away from cash and into the market, she said.

“The fixed income sector is really developing and evolving – in the 70s and 80s fixed interest was largely government bonds, and the instruments and the counterparties have certainly made a more complicated environment,” Dullahide said, adding the lack of understanding of fixed income may have contributed to some of the issues during the GFC.

“Those fixed income funds which are more actively managed will really have a very promising and important role to play in people’s portfolios as they start taking more risks.”

However, Chun sees investors jumping fixed income and bonds completely and diving straight into the share market when the time comes.

“With bonds, unfortunately, the whole difficulty consumers have understanding fixed interest has meant that for most people it’s been about cash or going to the share market,” he said.

But Colonial is advocating portfolios where investors are in bonds with duration and credit risk.

“We are for taking different types of risk to generate a return instead of just a polarised model of swapping between cash and shares,” Chun said.

Outlook

Whether investors stay in cash or start returning to the investment markets is going to depend on events in Europe.

Uncertainties surrounding Europe and the US are still casting a very dark shadow on investor sentiment, and the next 12 months will see investors remain very cautious.

But the year 2012 will also bring more innovation into cash. For both Macquarie and CFS, the theme of generating income still holds true, with both institutions flagging the development of new cash products and the technology surrounding them.

ING Direct, too, is expecting aggressive cash portfolios in 2012, forecasting cash sector growth until at least 2015.

These predictions and data on cash allocation from the past 12 months could result in another slow year for fund managers, but Barry Whyatt from AMP believes excessive allocation to cash could result in bad news for investors, too.

“The danger is – come April the markets could suddenly bounce upwards very quickly and we could suddenly go from 4,200 to 4,800 in the blink of an eye, and people would have missed out on 10-15 per cent growth very quickly,” he said.

“You’ve also got to watch the inflation rate; at the moment the rate you get in term deposits is higher than the current CPI [consumer price index], so you’re not losing money in real terms – but if the interest you get in a term deposit gets below inflation rate, then you’re losing money in real terms.”

Investors and their financial advisers will ultimately need to stop thinking about the preservation of capital and shift their focus to funding their retirement, said Dullahide.

“Ultimately, that preservation [of capital] is not relevant to the cost of living, so at some point in time it is important that investors do start thinking about how you go from preserving your capital in an absolute sense to preserving your capital relative to your growing costs of living – and then potentially looking to grow it,” she said.

Both Dullahide and Whyatt believe 2012 will finally bring that shift from short-term thinking to long-term.