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Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.
The right thing for investors to do in 2023 was to ignore the worrywart consensus huggers (myself included) and leap with both feet in to a heady portfolio of the zingiest stocks. You only live once.
Hindsight is a wonderful thing, but still, such a strategy would have delivered remarkable gains. The Nasdaq Composite index of techy stocks jumped nearly 40 per cent in the year, 20 percentage points more than on the US benchmark S&P 500. The gap was even wider with the broad market trend in Europe, particularly the UK which trotted along in its customary position at the back of the pack.
Instead, pretty much everyone, from retail investors to big institutions, feared a recession in the US and caught a serious case of the heebeejeebies. Most tucked a large slice of funds away in cash: not the physical kind stuffed under a mattress but easy-access pots of money like interest-paying deposits, money market funds, short-term government debt and the like.
Cash is always king at times of market anxiety. But last year in particular, this notoriously dull asset class delivered its best returns in a generation thanks to the rapid ascent of benchmark interest rates. Investors were paid a reasonable rate of return (at least if you squint and ignore inflation) to be scaredy cats, worrying about an economic crash that never materialised.
This is leaving a lasting mark on asset allocation decisions. Whenever advisers recommend looking at potentially more lucrative long-term investments, the pushback is the same. “Why would you want to do that? Why not just [park] in cash until it becomes clearer?” said Karen Ward, chief market strategist for Europe at JPMorgan Asset Management late last year. “That’s the question we’re asked.” Cash, she said, has an “emotional appeal” that other asset classes just can’t beat. Even bankers and fund managers often privately confess that their own wealth is squirrelled away in these types of rainy-day funds and deposits, not in the whizz-bang funds and products they construct and sell for a living.
But large institutional investors are giving up on this marriage of convenience. Last month, Bank of America’s fund manager survey showed that cash holdings had shrunk to 4.5 per cent of portfolios, down from 4.7 per cent in the November survey and a two-year low. Strategists are banging the drum: cut the cash, stretch out in to longer-term bonds and in to equities, even if previous efforts at that last year proved painful.
Since the Fed changed its tune in mid-December and pointed to a willingness to cut interest rates — the prime driver for bond price gains that we have already seen on a huge scale — this has played out well. But Julien Dauchez, head of portfolio consulting and advisory at Natixis Investment Management points out: “The view now is that with monetary rates to be cut, investors [staying in cash] will expose themselves to reinvestment risk.”
In simple terms, every new slug of money heading in to cash now will earn lower and lower returns, assuming central banks do start chopping back rates. In contrast, longer-term debt locks in returns. And yet, some retail investors appear to be stuck in a cash rut. Marco Giordano, an investment director at Wellington Management, says this shines through in his conversations with clients including wealth management firms and fund selectors. “They understand the rationale for getting out of cash,” he says, “but they are struggling to get that point across to their underlying clients.” Some wealth managers themselves report that clients look at what worked last year — cash and the Magnificent Seven monster US tech stocks — and are reluctant to change.
Most fund managers agree it makes sense to keep a slice of funds in a safe pot to either deploy when opportunity arises or to pay a nasty bill. But as a strategic investment, if you are a pessimist who believes benchmark interest rates will indeed fall hard this year, cash products will become gradually less rewarding and long-term bonds have much further to climb. If, however, you are an optimist on economic growth, arguably a better way to play that is through smaller stocks, say those in the Russell 2000 index.
“I understand the temptation [of cash],” says Joe Davis, global chief economist at Vanguard. “But if you are going to stay in cash, when are you going to get out?” Waiting for a “clear signal” that the time has come to switch in to either equities or bonds is unlikely to yield results, he said.
After a slow start, wealthy retail investors may be starting to get the message. Christian Nolting, chief investment officer at Deutsche Bank Wealth Management says in general, his clients are no longer clamouring for more of the stuff in their portfolios. “We don’t see that they are so entrenched,” he says. “It’s not the time to wait and see. It’s easy to be risk averse but you need to find these pockets of growth.”
Maybe so. But it feels like many investors still need convincing, and that it would take only a mild outbreak of instability in stocks or a flicker of higher inflation for them to lean back in to the comforting warmth of safe, boring, dependable cash.
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