Issue: September/November 2008

Cash may be king for a day, but not for the long term

Trustees should be responsive – but to what extent should they react to every change in the investment climate? Guest columnist KEVIN LINGS, a STANLIB economist and fund manager, provides a sidelight on this perennial debate . . .

Investors and industry professionals face a special challenge when markets are volatile, risky and uncertain. Retirement fund trustees feel particular pressure.

Investors and industry professionals face a special challenge when markets are volatile, risky and uncertain. Retirement fund trustees feel particular pressure.

If they take a long view and make only miniscule changes to investment strategy, they might be accused of ignoring market developments. Yet if they decide on a radical portfolio overhaul, they risk criticism for lack of vision.

The issue is highly topical in view of the current ‘dash for cash’ when some equity sectors have taken big knocks. For example, resources were down 30% in early August.

In recent months, both retail and institutional investors have enhanced their cash positions. It’s not only local investors who have moved into cash in a big way. By mid-August, a record $3,3 trillion was sitting in the US money market.

From a short-term perspective the case for cash looks compelling. Locally, it was the best performer in the first half of the year and continues to look appealing on a risk-and-reward basis. Cash returns currently equal the inflation rate, though the class falls a little off the pace after tax.

The danger is that investors will linger longer in cash than is good for them, lulled by the sense of safety. In the long term, cash is not king; the share market is.

History confirms that equities are the best performing asset class over time. Admittedly, they don’t always outperform. Since 1960 equities have produced a negative return in 11 calendar years or 23% of the time. With bonds it’s been 25%.

Measured over the past five,10, 15 and 20 years, equities have been the best asset class. Cash, in contrast, has consistently been the worst performing asset class over time and has failed to beat inflation over the past 20 years.

Another fact confirmed by history is that the period of maximum equity market pessimism is often the time of greatest opportunity. So stay in the market if you can.

At a low point, however, investors frequently shift asset allocations, moving out of sectors that have caused them pain and into options that seem to offer more comfort. Yet this is precisely the time, says history, that they should consider a move into the classes that have been hard hit and show poor returns.

Moves into and out of cash can also be difficult to time, but the general principle is that cash investments should be short-term as they only do well for a limited period. In the mid and short term, cash struggles to keep up.

SA investment history shows that equities have never delivered negative returns over any four-year

period. Cash as the dominant element in a portfolio tends to be value-depleting rather than value-enhancing in all but the most exceptional cases. In general terms, cash should be seen as a short-term holding strategy.

Is there any basis for believing that strategies based on long-term factors will generate the sort of returns that might insulate trustees from criticism that they don’t react fast enough or smart enough when volatility sets in?

Some solace is provided by the recent success of the STANLIB Balanced Trustees Fund of Funds in the Morningstar awards for top risk-adjusted performance. It was the top performer over 12 months in its category, yet fund strategy is driven by top-down macro-economic considerations and a balanced, generally conservative approach to asset allocation.

Performance is underpinned by judicious theme plays rather than stock picks. Long-range trends and SA’s general policy environment tend to shape the up- or down-weighting of asset classes and equity sectors.

The success of a balanced fund at a time of market volatility indicates that you don’t have to engage in smart tactics and slick timing to obtain acceptable returns. Strategic insight can smooth the way to steady gains at acceptable risk.

The ability to mitigate risk while demonstrating measurable gains could be a trustee’s job description at times of market uncertainty. Risk management is key. Cash, despite appearances to the contrary, is not a risk-free investment; inflation sees to that.

Kevin Lings

Consider the dilemma facing those investors with $3,3 trillion in US money markets. They’re earning 1%-2% while headline inflation is at 5%. How much long-term value will they create if they accept such negative real returns for any length of time?

It’s understandable when trustees build cash positions. But cash is never king for long.

Lings is manager of the STANLIB Balanced Trustees Fund of Funds and an economist at STANLIB, SA’s leading asset manager and largest unit trust company.