One of the problems with historically low interest rates is it reinforces the idea that cash is “trash,” a worthless asset destined to lose ground to inflation. That’s a pity, considering that cash is a major asset class, behind only stocks, bonds and perhaps real estate.
Cash is special, if only because it’s always useful for purchasing any of these other asset classes. That’s why deep-value investors always like to set aside a chunk of their portfolios in cash so they can snap up bargain-priced stocks during panic sell-offs. This is what they call “keeping your powder dry.”
In a sense, cash is like an investor’s oxygen. It’s everywhere and we must breathe it to survive. How do we assess the value of a business or stock? Largely by how much cash (or dividends) it throws off. Real estate? By the amount of rental income it generates, which is just another form of cash. Longer-term bonds? By the coupon or interest paid out, which in the end is yet another variant of cash.
It’s an obvious point but in the real world, we never buy something with a share certificate, a brick or a gold bar. We put up cold hard cash or its electronic equivalent via a debit card or credit card.
The disconnect between cash today and investing for tomorrow
So how is it possible that cash can simultaneously be viewed as “trash?” The disconnect arises because of the concept of investing for a far-off future. In order to maximize cash in old age or at least five years from now, investors try to transmute cash into various alternatives that promise but rarely guarantee better returns than cash can generate in the short term. At the same time, though, they are embracing risk of loss, a fear that has been more or less pervasive ever since the stock market crashed in 2008, taking with it just about every other asset class except: well, you know, cash!
As veteran Dow Theory theorist Richard Russell often points out, in a bear market when most other asset classes are falling, those holding only cash are participating in a bull market in cash. Even if interest rates were zero, relative to plunging wealth elsewhere, breaking even with cash would be a good thing. Lately, Russell has been bearish with a preference for cash and gold.
Many small investors appear similarly skittish. For the many burned by the financial crisis and its aftermath it seems to be a valid case of “once bitten, twice shy.” A survey issued mid-July by BlackRock Canada’s iShares of 551 Canadians with at least $100,000 in financial assets found market fears are indeed driving investors to cash even though most still expect poor returns. See David Pett’s report in the FP here.
A “guaranteed negative return?”
Seventy-seven per cent believe the fear of poor market performance is driving investors to boost their cash holdings, even though 67% view cash as ultimately leading to “a guaranteed negative return.”
iShares head Mary Anne Wiley (who is also managing director of BlackRock Canada) is adamant that “holding cash is not the answer.” Naturally, she believes ETFs that hold high-yield corporate bonds, emerging market sovereign debt or dividend-paying stocks are all better choices for long-term investors. Most ETFs are almost as liquid as cash since they can be sold on stock exchanges throughout the day (although with no guarantee of selling at a profit).
The wealthier the investor, the more likely they are to eschew cash for such alternatives. The survey finds HNW (High Net Worth) investors with at least $250,000 of investible assets are more likely to seek liquidity (57% of them do so) and 46% are more likely to seek diversification by sector, including (in 37% of cases) access to foreign markets. Foreign exposure is viewed as particularly important for those with at least $500,000 to invest.
The survey also underlines a noticeable lack of confidence in any investment decision made in the current economic environment. Sixty-eight per cent of the wealthy investors surveyed feel “much less confident” about their investment decisions than they were in the past and they’re also a lot more conscious about investment costs.
The survey doesn’t get into it but investors don’t have to choose between all-cash and all-equities. This shouldn’t be an “all or nothing” decision that keeps you awake nights if you make the wrong choice. There are various hedging strategies available, many of them using inverse ETFs or ETNs (exchange-traded notes), which let you participate in the hope of stock gains while also hedging some of your portfolio against downside risk. But a full treatment of this topic is for another day.