Partner Insight: Cash, the once and future king

This year’s flood of capital into cash investments after a decade of negative returns has been well documented. Our fixed income investment team examine the UK as a case study and discuss why they believe forward interest rates suggest cash could reign as king for a while.

clock • 5 min read
Partner Insight: Cash, the once and future king

The past decade brought scant returns from investing in cash, but that picture has changed profoundly in the past year. If the ‘higher-for-longer' mantra over interest rates currently being chanted by central banks plays out, the total return experience for cash investors will look very different for years to come.

Even if we haven't reached the peak in rates, we are close. In this context, a look back at the aftermaths of past hiking cycles gives an idea of how total returns compare across different asset types. This week's Chart Room takes the UK as a case study, looking at the benchmark money market rate, the sterling overnight index average (SONIA), as a proxy for cash and comparing its returns against bonds, the excess return over gilts of the ICE BOA index of all maturity Sterling credit, and stocks (the FTSE 100) following the peak of past rate hike cycles. One thing that's immediately clear is the consistency of cash returns relative to riskier assets. Aside from a blip in the short-lasted rate rises of 2018, overall cash returns outshine credit returns in the aftermath of a rate rise cycle, while also avoiding the volatility of equities.

In the UK's case, the current forward curve also tells us that the market is expecting the Bank of England's (BOE) base rate to remain well above 4 per cent for the next 5 years. As of October 23rd, that rate was expected to be 5.07 per cent in one year, and 4.59 or 4.38 per cent in two or three years respectively. Money market yields track base rates, so higher base rates naturally bolster money market returns.


Long-end volatility

Much of this also applies to the situation in other cash markets. But of course, there are idiosyncratic factors at play. With peak rates in sight and less uncertainty over changes in monetary policy, there has been a shift of volatility in rates and government bond curves from the front end to the long end. The curve is bear steepening, meaning yields overall are going higher, but it is the long end that is now driving volatility. Traditional UK buyers of long-end paper, such as pensions and liability-driven investment (LDI) schemes, are not coming to the rescue as they are now in restructuring and de-risking mode following the mini-budget crisis in September of last year.

What's more, the BOE's ongoing campaign of quantitative tightening and continuing heavy gilt issuance by the UK government to finance the budget deficit are increasing volatility in longer maturity bonds. Putting all these pieces together leads to higher term premiums, where investors require additional compensation for holding longer duration assets, and therefore bodes less well for that part of the curve.

Then there's inflation. While UK inflation has eased and should improve further as the base effects of last year's big energy price increases dissipate, we are still well above target. If the higher-for-longer narrative plays out, given the elevated volatility elsewhere, the attractive risk-adjusted yields in money markets should make them fertile ground for investors.

See also: The dash for cash is on​

Today's investors face a challenging prospect of an oncoming recession and elevated market volatility, which may lead them to question their risk appetite and asset allocation.

Against this backdrop, we highlight the reasons why now is a good time to be allocating to cash in your investment portfolio.​

 

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Important information

The value of investments and the income from them can go down as well as up and clients may get back less than they invest. Past performance is not a guide to the future. Investors should note that the views expressed may no longer be current and may have already been acted upon. Fidelity's range of fixed income funds can use financial derivative instruments for investment purposes, which may expose them to a higher degree of risk and can cause investments to experience larger than average price fluctuations. Changes in currency exchange rates may affect the value of investments in overseas markets. Investments in emerging markets can also be more volatile than other more developed markets. The value of bonds is influenced by movements in interest rates and bond yields. If interest rates rise and so bond yields rise, bond prices tend to fall, and vice versa. The price of bonds with a longer lifetime until maturity is generally more sensitive to interest rate movements than those with a shorter lifetime to maturity. The risk of default is based on the issuers ability to make interest payments and to repay the loan at maturity. Default risk may therefore vary between government issuers as well as between different corporate issuers. Sub-investment grade bonds are considered riskier bonds. They have an increased risk of default which could affect both income and the capital value of the fund investing in them.  An investment in a money market fund is different from an investment in deposits, as the principal invested in a money market fund is capable of fluctuation. Fidelity's money market funds do not rely on external support for guaranteeing the liquidity of the money market funds or stabilising the NAV per unit or share. An investment in a money market fund is not guaranteed. The investment policy of these funds means they can be more than 35% invested in transferable securities and money market instruments issued or guaranteed by an EEA State, one or more of its local authorities, a third country or a public international body to which one or more EEA States belongs. Investments should be made on the basis of the current prospectus, which is available along with the Key Investor Information Document (Key Information Document for Investment Trusts), current annual and semi-annual reports free of charge on request by calling 0800 368 1732. Issued by FIL Pensions Management, authorised and regulated by the Financial Conduct Authority and Financial Administration Services Limited, authorised and regulated by the Financial Conduct Authority. Fidelity International, the Fidelity International logo and F symbol are trademarks of FIL Limited. UKM1123/384574/SSO/NA

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