Market Views: If cash yields 5%, why invest in other assets?
After a painful 2022, asset owners across Asia have broadly adopted a risk-averse mentality.
Higher policy rates make the prospect of simply holding cash or bank deposits quite attractive, although for investors involved in carry, there is a higher price to pay as well.
It is easy to secure 5% yield on cash deposits in the US and the UK and between 3% to 4% in Europe and markets such as Hong Kong. Investing in mostly risk-free government bonds makes no major difference.
However, as inflation in the US shows signs of softening, should investors start to position themselves for a changing macro environment? Where will rates be in 2024?
AsianInvestor asked fund houses reasons why asset owners should put their money anywhere else other than cash, and what the options are.
The following responses have been edited for clarity and brevity.
Marc Franklin, senior portfolio manager, asset allocation, Asia
Manulife Investment Management
While US interest rates and, therefore, short-dated Treasury yields are currently sitting close to 5%, the reality is that we are currently experiencing a period of cooling inflation.
This may create room for policymakers or, at the very least, market pricing to discount rate cuts over the next 24 months.
With this in mind, we would not expect cash yields to remain at 5% forever.
Moreover, various asset classes would stand to benefit from fading interest rate expectations.
US Treasuries, as well as other investment grade sovereign bond markets would attract investor interest given slightly improved term premium on offer and the potential for effective yield compression. High carry sovereign issuers such as Mexico would also benefit from increased investor risk appetite, especially if US dollar strength moderates.
In addition, rate-sensitive equities and longer-duration equities would likewise benefit from cooling rates pricing.
Combined with secular growth potential, sectors such as nuclear energy, cybersecurity, and broader technology would experience renewed interest in the near term, especially with significant share buyback programs activated.
Longer-term, however, we need to be vigilant for any signs of renewed upwards pressure on inflation, especially if financial conditions ease too much.
In that scenario, policymakers would need to proactively signal that there would be limited room for policy easing which could trigger a flight back to high-yielding cash-like instruments.
Sylvia Sheng, global multi-asset strategist
JP Morgan Asset Management
Cash rates are unlikely to stay elevated for long, and that carry hurdle will quickly fall. Investors should remember that sitting in Treasury bills might mean collecting 5% for limited risk today, but it misses out on compounding returns over the longer run.
In short, extending out of cash is imperative.
According to our latest long-term capital markets assumptions, we estimate that a dollar invested in cash will be worth, in real terms, $1.04 a decade from now, whereas in a simple public market 60/40, it would grow to $1.54, and in a 60/40 with 25% alternatives, it would be worth over $1.60.
Over the next 10 to 15 years, we believe that we face the challenges of a world in transition, from disinflation to two-sided inflation risks, and from policy accommodation to higher costs of capital.
Building smarter portfolios for a world in transition demands that investors extend out of cash and benchmarks to harvest better returns within existing opportunity sets.
Expanding opportunity sets, particularly into alternatives and through greater international diversification, can open up new axes of both return and diversification.
And with greater two-way inflation risk and a shift in the sources of capital, we see increasing opportunity for investors to enhance returns through active alpha and manager selection.
Wang Taosha, portfolio manager
Fidelity International
Nothing lasts forever, including 5% cash rate, which is a short-term interest rate.
It is applicable to cash investments with a maturity of only up to one year.
This means investors face reinvestment risk, at the end of the one-year investment horizon, because the interest rates are likely to have become lower by then.
In fact, the Fed is widely expected to start cutting policy rates in early 2024, as inflation continues to soften.
Based on current market pricing, investors looking to reinvest their cash this time next year will only earn a little over 4% cash rate.
Meanwhile, the US dollar won’t always smile.
For Asian investors who have home currencies that are different from US dollar, the exchange rate is another important consideration. The strength of US dollar should not be taken for granted. The US dollar has traded strongly relative to other currencies for some time.
This has been driven by the rising US dollar interest rates, which is probably going to reverse itself as inflation softens. If the dollar were to weaken against Asian currencies, the total return for Asian investors, expressed in their home currencies, would be lower.
On the upside, investors will simply miss out on potentially significant returns if they choose to hold only cash.
For example, there are exciting equity investment opportunities in the technology space, particularly ones related to the artificial intelligence value chain.
We recommend that investors adopt a balanced approach and construct well-rounded portfolios that include various equity and fixed income instruments.
Cash is a valid portfolio building block given the level of current yield but it certainly is not the only game in town.
Deborah Bannon, head of institutional distribution APAC ex Japan, consultant relations APAC
BNY Mellon Investment Management
Asset owners have always needed to build long-term resilient portfolios that are diversified. This need has been heightened most recently as we are in an era where there are multiple factors of disruption in markets.
How asset owners position portfolios to manage some of these risks is important. This has seen many asset owners revisiting their long-term strategic asset allocation and even looking to increase flexibility to access more tactical opportunities.
Also, we have to consider that when we enter a tightening phase it will impact liquidity and so perhaps traditional asset classes will again be more attractive than cash.
Whilst rate increases might have peaked, there is no doubt that we are in a higher for longer environment and we do see demand for fixed income continuing. We favour active fixed income in this regard.
We also see continued demand for alternatives such as private markets and infrastructure to generate higher returns.
Jenny Zeng, chief investment officer, fixed income Asia Pacific
Allianz Global Investors
We believe fixed income is ready to make a comeback, particularly in the Asian market, due to several factors.
Firstly, Asia is expected to contribute significantly to global economic growth in 2024.
South Asia is identified as a region with high growth potential and productivity in the coming decade, driven by supply chain diversification and a young population.
As macroeconomic fundamentals improve, sovereign credit ratings in these countries will likely be raised, leading to a repricing of fixed income assets.
Secondly, increased intra-regional activities will gradually desynchronise Asian economies from the US and make them more influenced by regional factors and flows.
This will result in reduced currency volatility and a fundamental repricing of Asian fixed income assets.
Furthermore, Asian bonds provide an effective hedge against market volatility and the global economic slowdown.
Historically, Asian local currency government bonds have exhibited the lowest beta to US treasury bonds among emerging market bonds, offering competitive yields and diversification.
Additionally, despite tight valuations, Asian investment-grade bonds should remain resilient in comparison to other markets, with a favourable risk-reward profile supported by a strong banking system and corporate balance sheets.
Notwithstanding continuous US Treasury volatility and overall emerging market outflows, at the current yield levels, building a basket of quality BBB and BB names to achieve 9%+ yield remains attractive for long-term investors considering the region's relative growth in the coming year, with reasonably low default risk in the yield level thanks to overall favourable credit cycle in this region.
Be reminded that most Asian countries have abundant liquidity in their respective banking systems and local currency markets serving as alternatives for refinancing as US yields are likely to stay higher for longer, and therefore taking refinancing risk in this region is not a bad idea.
Andy Wong, senior investment manager, international multi asset
Pictet Asset Management
Unlike last year, the opportunity cost of not investing can be high – just look at the performance of the “magnificent 7” (US tech giants such as Apple, Meta, Nvidia and Tesla).
We see opportunities globally and across asset classes. Long-term real yields are attractive.
After trending lower relentlessly and into negative territory during 2020 and 2021, investors can now lock in 2%-2.5% real returns for a long time.
We are techno-optimist and maintain strategic asset allocation to secular growth themes.
Our favoured themes include the tech ecosystem of the information era and “semiconductor is the foundation of modern technology”, most recently manifesting themselves as generative AI.
Security should be a part of the new ESG. Food and energy independence also have a place in the portfolio.
Given current geopolitics, Japan and India are favoured in the “new ping-pong diplomacy” era. We obtain exposure through supply chain strengthening, equipment, industrial and financials.
Despite market doom and gloom, geopolitical uncertainties, and a high cash rate, there is resilience and attractive opportunities in select themes. The opportunity cost of not investing can be high.
Michele Barlow, APAC head of investment strategy and research
State Street Global Advisors
While cash yields remain attractive today, the prospect of a significant slowdown in economic activity means that government bonds will offer investors an increasingly attractive proposition over the medium term.
As the most recent rate hikes have yet to take their toll on an economy already facing an inevitable slowdown, and we believe a disinflation dynamic has a bit further to run, this policy-driven cycle favours an overweight duration position in US Treasuries as lower rates and a bullish steepening are priced in.
Outside of the US, this may play out slightly differently as core inflation remains higher or has shown signs of being stickier in Europe.
\While the market may move to discount rate cuts sooner than currently implied, there is still a risk that inflation becomes more entrenched with higher energy prices impacting headline inflation.
However, the risk-reward profile (yield per year of duration) across several European markets is at its most attractive level in a decade or more in short-dated bonds.
Tight monetary policy and slower economic growth dampen the outlook for equities in 2024. Amid heightened volatility, we favour selectively owning aspects of the market that exhibit characteristics of quality investing.
The US market is preferred due to its sector composition and competitive advantage of its companies. For various structural reasons, we believe Japan should maintain its momentum of positive performance into the new year.