Asset Allocation

After such robust performance from equities and bonds in 2019, many investors are now seeking safety in cash. But is cash really the best investment for 2020?

In the last 40 years, there have been only five calendar years when holding cash has been better than investing in either bonds or equities in the US*. True, benign inflation, rapid globalisation and technological developments have fuelled an incredible period of success for balanced-fund strategies that buy equities and bonds, as proved the case in 2019.

But today, it's hard to find any developed market bonds that provide a yield above 2%. At the same time, equity valuations are as high as they’ve ever been since the 2000 bubble. After a dramatic slowdown in global growth in 2019, we don’t hold out much hope that stronger growth will save the day.

Perhaps it’s no surprise, then, that investors are worried about their money this year and have been piling into money market funds. In the last two years, money market fund assets in the US have risen by US$ 1 trillion. Merrill Lynch investor surveys and analysis of its own client accounts show investors currently have elevated cash levels (see Chart 1).

Chart 1: Investors are seeking safety in cash

Source: Bloomberg (as of January 2020)

2020 – the year for cash?

Is cash really the best investment for 2020? This seems highly unlikely, in our view, for several reasons.

Real interest rates are negative

In every one of those years when cash beat bonds and equities, real interest rates (‘real’ meaning after taking account of inflation) were positive. In 2019, global central banks collectively made 80 interest rate cuts and pumped over US$400 billion into the world’s financial system, reducing cash returns to negligible, sub-inflation levels across developed markets. With such an abundance of cheap money sloshing around, we don’t expect real interest rates to be positive in any major economy in 2020.

There’s always a good investment somewhere

The historical analysis above relates only to equities and Treasury bonds in the US. Today, capital is able to move much more freely around the world in search of the best investment opportunities. For example, emerging market bonds currently provide a yield of around 5%. Yields on comparable developed market government bonds are much lower: under 2% in the US, around 0.5% in the UK and negative in many European countries. Emerging market debt is one of several strategies we like that potentially offers an attractive trade-off between risk and return.

Today, capital is able to move much more freely around the world in search of the best investment opportunities.

If nothing’s going up, go short

Unlike previous decades, it’s now much easier for investors to access alternative investment processes that aim to deliver positive returns irrespective of whether markets are rising or falling. To achieve this, so-called ‘absolute return’ funds manage investment risks more precisely and use all investment tools and techniques available. This includes taking short positions that make money when an asset price falls.

Put your cash to work

Holding cash may feel secure. However, in reality it comes with three insidious effects. It is eroded by inflation, which, despite currently being low, soon adds up. There is the opportunity cost of the returns that you might have had, if you had been invested. Most significantly, there is a timing risk when you do decide to put the money to work. As others put their cash to work before you, they drive up asset prices, making your decision to invest more risky – there is a cost to being last.

As we enter a year when real interest rates are negative, cash may soon become a hot potato.

* Source: Bloomberg, January 2020. Past performance is not a guide to future returns.

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