Considering Cash

As an asset class, cash doesn’t get the attention it deserves. True, it generally has a zero and sometimes a negative expected real return, but there is a near certainty around that expected return. 

At present, telling investors you find cash an attractive asset is not easy.

Since risk assets should return more than cash over time the bias should be tilted towards owning them in preference to cash. Most of our peers feel philosophically compelled to hold as little cash as possible. They feel that their clients don’t pay them to sit in a supposedly ‘dead asset’. 

However such a view effectively pushes investors towards owning risk assets at virtually any price, which is neither sensible nor desirable. Moreover, the job of the investment manager is not to indiscriminately ‘put money to work’ but to exercise judgement in allocating it to the highest expected return for a given amount of risk. While that will generally be in risk assets, something which is generally true isn’t true at all times, necessarily. On purely valuation grounds, cash will sometimes be the most attractive asset to hold. 

Cash has one important attribute which is too frequently unrecognised: a hidden optionality derived from its relative stability. In other words, the holder of cash has an effective option to purchase more volatile assets, if and when, they become cheap or at least, cheaper. Thus, a willingness to hold cash when there are no obvious alternatives is a simple way of keeping one’s powder dry during times such as now.

At Tacit, all investment strategies aim to provide returns above inflation over an investment cycle. Therefore, holding cash is a drag on this objective and we would only hold it if we believed a better opportunity would be afforded to purchase our favoured equities or bonds. 

Many clients today tell us the reason they don’t feel comfortable owning cash is because they don’t trust central banks to preserve the value of cash. Regular readers will be aware that we share such concerns. Nonetheless over time, nominal interest rates have generally tracked the rate of inflation, effectively compensating the holder of cash for any on-going debasement. It is worth remembering that in the 1970s when the inflation rate was double digit so were interest rates.

We remind investors that the real return from cash in the 1970s was actually on a par with bonds and equities and that if inflation becomes an issue, interest rates will rise very quickly to compensate.