The death of cash as an asset-class

Christopher Joye

Coolabah Capital

In the AFR this weekend I write that super funds have a problem with their pure cash options right now as net returns are approaching zero and starting to turn negative. As an asset-class, cash is meant to provide capital stability and liquidity. And yet with the actual RBA cash rate (as opposed to the RBA’s target rate) sitting at just 0.13 per cent and cash-like instruments, such as short-term bank bills, offering only 0.10 per cent, it is hard for super funds to provide a cash option with positive returns after accounting for their 0.25 per cent administration fees and any other costs of managing cash. Click on that link to read or AFR subs can click here. Excerpt only:

One solution might seem to be term deposits, where you can still earn around 1 per cent. But I have heard multiple stories of the banks turning away institutional investors wanting to place large sums in term deposits because they are flush with funding.

The challenge is the banks have attracted huge deposit inflows because of both the risk-aversion induced by the crisis and their once-very-attractive TD rates (recall they temporarily offered 1.7 per cent rates after the second RBA rate cut in March). At the same time, their balance-sheet growth remains sluggish because business and household credit growth is constrained as a result of COVID-19.

Over and above deposits, the banks also have access to ample low-cost funding via the RBA’s new Term Funding Facility, which has been crucial for supporting their now skinny, single-digit returns on equity. Whereas a 12 month term deposit costs a bank around 1 per cent, they can borrow three-year money from the RBA at a much lower rate of just 0.25 per cent under the TFF.

For the avoidance of doubt, the death of cash is absolutely part of the monetary policy plan as the RBA seeks to reanimate economic activity. By crushing returns on risk-free savings, policymakers are encouraging households and businesses to explore other investment opportunities. The goal of this column is to outline the stair-case of near-cash opportunities, moving from lower-to-higher risk in liquidity, volatility and creditworthiness terms.

Most investors are unfortunately stuck with this unavoidable risk/return trade-off. A tiny minority can generate superior returns from low-risk and liquid assets by trading them very actively, although that luxury is not available to mums and dads.

So let’s start by understanding what exactly cash is. What we think of a riskless cash deposit is actually a senior-ranking, unsecured loan to a bank. If we have less than $250,00 in the deposit, it is protected by a government guarantee. Above this threshold, we are taking pure bank credit risk.

The odd thing about deposits is that we do not revalue them day-to-day. We hold them at face value and assume our investment is never at risk, even though there are always residual probabilities of loss. To illustrate this point, there are actually safer bonds issued by the banks that sit above deposits in the capital structure. These are known as “covered bonds”, which denotes their secured, as opposed to unsecured, status. A covered bond gives an investor recourse to both the bank and a pool of assets that the bank pledges to protect investors in an event of default. (Deposits don’t have this benefit.)

While theoretically the risk of loss on a covered bond is lower than cash in a bank deposit (above the $250,000 government guarantee), the value of covered bonds fluctuate up and down every day—albeit modestly—based on the market’s estimates of the change in the creditworthiness of the issuing institution. You could technically have a small paper loss on a covered bond while your riskier bank deposit superficially appears like it has outperformed.

A AAA-rated Bank of Queensland covered bond currently offers an all-in interest rate of about 1 per cent annually, similar to what you get on a 12 month TD, but notably way above the RBA’s current 0.13 per cent cash rate. The covered bond is however tradeable, which means it affords daily liquidity in contrast to TDs that normally lock your money up for at least one month.

Read the full column here.

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Portfolio Manager & Chief Investment Officer
Coolabah Capital

Chris co-founded Coolabah in 2011, which today runs over $8 billion with a team of 26 executives focussed on generating credit alpha from mispricings across fixed-income markets. In 2019, Chris was selected as one of FE fundinfo’s Top 10 “Alpha...

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