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Investment Strategy
Tuesday, July 1, 2008
The risky side of cash

In all the turbulence swirling around investors today, cash has become a popular choice for investors. But cash can be a risky asset if it is not managed correctly.
Cash is often considered to be a safe haven particularly by retired investors. One’s capital is secure and it provides a high income, especially in times of rising interest rates. However, investors can be lulled into a false sense of security by remaining invested in cash for too long. The economy is dynamic and a time will come when cash is no longer the most appropriate place to be. At that stage, investors seeking a high income should rather choose other asset classes, such as bonds and property.
Investors, though, can be complacent and sluggish in making the decision to move away from cash or might even become so used to the capital stability seemingly offered by cash that they don’t want to change their investments even if they would benefit from the switch.
While cash does offer capital stability, that is not enough. Inflation erodes capital values and by staying in cash too long, an investor will not maintain purchasing power. If inflation were to average, say, 6% over the next five years, R10 000 in the bank today would only be able to purchase R7 473 in five years’ time. In effect the capital has been reduced by a quarter!
The income from cash has also proved to be quite volatile, creating a different form of risk for an investor. In times of rising interest rates, cash offers a growing income stream. But when interest rates start to decline, that income falls and it can fluctuate wildly in the long term. Although retired investors with cash savings are currently enjoying higher interest rates, their income almost halved from 2003 to 2004 as interest rates declined and remained low until they began rising again in June 2006.
Other asset classes, such as bonds and listed property, can also provide investors with a relatively high income. In fact, the income from bonds is secure over the life of the investment and property income, backed by lease agreements, can be more reliable than income from cash and can grow over time. However, capital values of these investments vary over time.
Bond and listed property values are influenced by several factors, notably interest rate movements. In times of falling interest rates, bond and property values rise but in times of increasing interest rates, they decline. In 2003, as interest rates fell and the income from property rose, listed property values increased on average by a whopping 25% every year. But both bond and listed property values are considered high at present and the risk is on the downside, so cash has become the current asset class of choice.
So how can an investor who requires an income stream benefit from investing in these asset classes while minimising the effects of their inherent risks? The answer is to blend the assets over time and to manage that asset allocation. As can be seen in the graph income from cash (red bars) and income funds (black bars) has fluctuated over time. However, income generated by an asset allocation fund (in this instance the Marriott Core Income Fund – blue bars) has shown far greater consistency over time, while at the same time producing far superior capital growth.
For income-dependent investors, this is a good solution.
Such investment management needs careful tending and investors may benefit by selecting an asset management house with the necessary skills rather than managing the blending themselves.
Cash may provide a good home to investments at the moment, but not necessarily for much longer. A careful blend of cash, bonds and listed property managed over time will provide a reliable, high and growing income, as well as relative capital stability.
Nor should investors ignore equity, even though this may appear counter-intuitive at the moment.
Says Tony Barrett, head of wealth management at BJM, “A cash-heavy portfolio seems like a sensible and mature option at the moment, but the lost opportunity cost of such a strategy should not be ignored.

“You will not lose money by sitting in cash, but you will not benefit from any growth or bounce that may befall equity markets. A number of JSE stocks have literally been decimated since the top of the market in October 2007. These are still by and large solid companies with good business operations and good future potential.
“Equity markets are known to overshoot on the top side at the peak of a market cycle, but they also oversell on the downside when sentiment is at its worst.”
The way to exploit this overshoot at the bottom is to seek well-researched equity opportunities rather than move to the sidelines.
“We do not know the exact bottom of the market,” says Barrett, “but we do know that equity markets eventually always bounce back to new highs.
“Often the best time to invest is when it feels like the wrong thing to do.”
Based on information from BJM Private Client Services. For further information please contact Mike Ronald on 031 366 1173 or 083 259 5923

Copyright © Insurance Times and Investments® Vol:21.6 1st July, 2008
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