Cash as a diversification tool

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With the recent increase in the repo rate and further projected rate increases to come, cash as an asset class should be revisited by those investors who have not already done so.

Investing in the stock market and sitting on cash might seem like mutually exclusive options, however cash instruments play a key role in the successful diversification of portfolios, especially through times of volatility, like global markets are experiencing.

Increased volatility:

Global markets have experienced significant volatility on account of numerous factors. The Ukrainian war, increased inflation as well as the Covid-19 pandemic have all been contributing factors to the recent equity sell off.

Himal Parbhoo, CEO FNB Cash Investments explains, “In times of market volatility and increased risk, cash instruments should be considered by investors as a diversification and risk mitigation tool.

“Adding a cash element to a portfolio allows an investor to decrease portfolio risk and secure an additional income stream in the form of regular interest payments. Different cash instruments can shelter portfolios in the case of large market moves and ensures an element of income is forever present in unfavourable equity environments.”

In a bull market, cash performance will be significantly lower to that of the stock market, however adding a cash element to your long-term portfolio, especially with rising interest rates, ensures yield is achieved regardless of market performance, as well as having a liquid asset class should the pullback present buying opportunities:

Cash as an offensive asset:

“Cash is typically viewed as a defensive asset class for the risk averse investor, however in times of increasing interest rates and decreasing equity prices, cash can be a powerful offensive tool in securing interest income, whilst offering the opportunity to capitalise on equity buying opportunities should the pullback result in good entry positions regarding value, “says Parbhoo. As the saying goes, “cash is king” and including a cash element within a portfolio means securing an additional income stream as well as having a war chest should equity prices pull back into value opportunities.

For the patient investor, equity pull backs can result in opportunities to acquire assets at below true value prices.

This will in turn increase returns over time. Cash allows you as an investor to capitalise when the moment is right and not have to first look to exit other long term asset positions to do so.

There are different types of cash instruments one can utilise as an investor:

Money market account: Money market accounts are offered by traditional banks. A money market account has similar characteristics to a traditional savings account, however, typically provides investors with a higher interest return. Money market accounts require customers to deposit minimum amounts and then maintain that minimum balance. The interest rates offered are variable and linked to the repo rate. The higher the repo rate the better the returns offered and the lower the Repo rate, the lower interest returns will be. 

Money market fund: A money market fund is a kind of mutual fund that invests in highly liquid near-term money market securities such as cash, cash equivalent securities, and bonds with a short-term, maturity of less than 13 months. Although not as safe as the money market account, this long-term savings vehicle is still viewed as a low-risk asset, providing higher returns than the standard savings account.

Notice deposit: This is a savings account linked to the Repo rate, that requires an investor to give notice before taking funds out of the account. The longer the notice period the higher the interest returns offered by the financial institution. This is still a variable interest instrument but can be used by investors with no immediate need for cash looking for higher returns than traditional savings accounts.

Fixed deposit: This instrument allows investors to fix the interest received over a fixed period. The longer the period fixed, the higher the returns offered. This instrument will not be impacted by changes to the repo rate when already acquired, however for investors looking to utilise this instrument post rate cuts, the rates offered will be lower.

This instrument allows investors to receive reliable and consistent cash flow in the form of fixed interest returns and can be used by both risk averse investors, and investors looking to hedge market risk with a reliable cash flow.

With increasing interest rates and decreasing equity prices on account of increased market volatility, cash can be used by investors as an offensive asset class. The immediate benefits of cash within a portfolio include further portfolio diversification, higher interest income on account of a higher repo rate as well as a highly liquid asset class to pounce on immediate market opportunities. This is why investors should be considering a cash element within their portfolios,” concludes Parbhoo.

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