03 April 2024
Over the last 15 years, investors have faced several significant challenges: the financial crash of 2008, Covid, conflicts around the world and the cost of living crisis. Today, the consensus is that interest rates have peaked, and we are simply waiting for them to fall. While cash can be a helpful backbone, especially in times of trouble, it's essential to appreciate the impact on portfolio performance when holding large amounts of cash for prolonged periods.
The Financial Times recently published a report by Capital Group into what was described as the "cash trap", the double-edged sword of holding cash, security and impact on long-term performance. Focused on high-net-worth investors, the report identifies some interesting trends and reveals some important facts about long-term investment returns.
As we stand today, over the last 20 years up to 2023, the S&P 500 index has an average annual return of 10.2%, with dividends reinvested. Contrast this against US interest rates, which currently stand at 5.5%, and we begin to see the divergences in performance. Traditionally, many experts believe that stock markets look forward, anything from six months to 18 months in advance. Consequently, the current valuations are based on the prospects further down the line.
This would explain the recent all-time high reached by the S&P 500 against what is still a complex economic background. At the start of the year, investors were hoping for six interest rate cuts in the US, but these hopes are being eroded, and now the consensus is for three reductions later in the year. So, how does this impact the amount of cash held by investors, and what are their opinions on cash, bonds, and equities going forward?
Currently, nearly 80% of high-net-worth investors hold more than 10% of their portfolio in cash. At the same time, 90% have less than 50% of their portfolio in equities, despite the recent strength of the US stock market. Ironically, much of this strength is centred on the "magnificent seven", a topic covered in one of our earlier articles. So, even as major stock markets continue to recover, many hitting all-time highs, most high-net-worth investors are still cautious.
The research examined equities, bonds, and cash and asked investors to consider the perceived risk of holding these assets over the next ten years.
In terms of the risk of holding cash over the next ten years, the respondents saw the level of risk as follows:-
· 25% saw no risk
· 36% minimal risk
· 28% moderate risk
· 11% significant risk
While it is always sensible to hold an element of cash in your portfolio, many high-net-worth investors still see cash as a relatively minimal risk to long-term returns. Are they in for a surprise in the long term?
When it comes to equities, the situation is a little different:-
· 6% saw no risk
· 22% minimal risk
· 56% moderate risk
· 16% significant risk
While more respondents saw equities as a moderate risk compared to other asset classes, it's essential to appreciate the potential risk/reward ratio.
As interest rates appear to have peaked, demand for fixed-interest investments such as corporate bonds has been healthy of late. The feedback from respondents regarding bond investments was as follows:-
· 15% saw no risk
· 44% minimal risk
· 30% moderate risk
· 11% significant risk
Interestingly, bonds scored highest with minimal risk, suggesting many investors are looking to lock in a high interest rate as the cycle starts to trend down.
This survey gives a fascinating snapshot of the views of high-net-worth investors over the next ten years. It is no surprise to see equities register the highest moderate risk, at 56%, although this must be considered in tandem with the potential returns. Even though there is still a degree of uncertainty regarding both economic and stock market performance in the short, medium, and long term, if interest rates do turn down as expected, will this reduce the short-term attractions of cash as a significant asset class?
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