The Cash Conundrum
The Cash Conundrum

For most investors, it is prudent to keep a proportion of one’s investment funds in cash for liquidity purposes. However, investors also need to keep in mind that cash returns have been extremely low for most of the past decade and are likely to fall further with the Reserve Bank of Australia tipped to cut rates further before the end of the year, as it seeks to stimulate the Australian economy.

According to the ASX/Russell Investment 2018 Long-term Investing Report, the gross return from cash has been around 3.6 per cent over the past decade. However, these sort of returns on cash are unlikely to be seen again anytime soon in the current very low interest rate environment.

Despite this reality, according to data from the Australian Prudential Regulation Authority, the amount of money sitting in low-interest bank savings accounts at Australia’s four largest banks (ANZ, Commonwealth Bank, NAB and Westpac) still totalled a massive $731 billion at the end of March 2019. Including all other authorised deposit-taking institutions, such as regional banks, building societies and credit unions, the total is more than $935 billion, with most of this cash earning less than 2 per cent per annum. Indeed, once inflation is taken into account, the real return on cash has actually been negative for the past six years.

While much of that cash represents at-call money primarily used to fund living costs, there is also a large swag of investment capital locked into these types of savings accounts. In fact, Australian Tax Office data shows self-managed superannuation fund trustees are holding just under $200 billion of cash in their bank accounts, which includes products such as term deposits. Cash as an investment allocation is still accounting for about 24 per cent of total SMSF assets, which is a strong indication that most self-managed funds have too much cash and are not sufficiently diversified.

In order to generate a sufficient return on cash, investors should first review their asset allocation, relevant to their risk profile. Cash holdings (in the form of cash or term deposits) should range between 0 per cent (very aggressive) to 35 per cent (conservative), with the rest of an investor’s exposure to defensive assets achieved via fixed interest securities.

Fixed interest securities include products such as direct corporate bonds, fixed interest (FI) listed investment trusts/ETFs (corporate and/or government bonds), as well as hybrid securities such major bank additional tier one securities. These products range across the risk/return curve for fixed interest, with some focussed on fixed rates e.g. corporate bonds and others linked to floating rates e.g. hybrids.

Investors should look to weight these securities appropriately, so as to give a degree of certainty combined with a higher yield on cash. This blended yield of fixed interest and cash, can be structured to achieve an average return on defensive assets yield of just under 4.0 per cent.

Consider the case below, for an investor with a balanced risk profile i.e. 50% in growth assets and 50% in defensive assets. Within defensive assets, our model recommends a cash position of 20% (which we have allocated; 5% in cash, 15% in term deposits), and a fixed interest position of 30% (allocation; 0% in direct corporate bonds, 17.5% in FI listed investment trusts/ETFs and 12.5% in hybrids).

Representative Returns and Weightings for Defensive Assets

Source: Patersons Research

While it is important to note that corporate bonds, listed investment trusts and hybrids do not have the same risk profile as cash i.e. their values can change in line with market conditions, we believe such a split can provide an appropriate risk return trade-off.

Warning: This report is intended to provide general securities advice, and does not purport to make any recommendation that any securities transaction is appropriate to your particular investment objectives, financial situtation or particular needs. Prior to making any investment decision, you should assess, or seek advice from your adviser, on whether any relevant part of this report is appropriate to your financial circumstances and investment objectives.