With inflation beginning to soar, using cash as an asset class to diversify portfolios is no longer applicable. Investors need to get more creative when it comes to allocating assets, says Matthew Yeates, head of Alternatives and Quantitative Strategy at 7IM.
An asset that could beat inflation and provide some protection for investors for much of the last two years, cash is now facing a real threat from soaring inflation in the UK and further afield.
The unprecedented stimulus packages thrown at economies to help them tackle the pandemic saw UK inflation jump to 2.1% in May, breaching its 2% target – something it hasn’t done since November 2018.
The long-standing notion of using cash to wait for good opportunities to invest no longer works.
Risk-free no longer gets you a return, and it means the opportunity cost with cash is now very high because you are effectively locking in a loss on anything you leave in cash. While it is essential to maintain a rainy-day fund in cash – we typically recommend starting with around six months of income – anything beyond short-term needs is better put to use elsewhere.
Keeping your powder dry just doesn’t cut it anymore, because – thanks to the record low rates on cash – investors are not keeping pace with inflation.
One of the main goals for most portfolios is to beat inflation consistently, and this creates problems for multi-asset portfolios in general. In order to stay true to risk mandates, investors cannot simply pile into equities instead of cash or bonds just to beat inflation.
We can’t just buy assets more exposed to risk. There are some pockets of value in fixed income – like European bank debt where you can get 2-3% additional yield versus comparable credits, or in mortgage debt in the US, where they have had 10-15 years of paying down debts post the GFC.
Other alternatives like private equity do not suit many portfolios because it is simply leveraged equity, while many corporate bonds paying low yields do not provide much by way of yield to counter inflation.
We don’t want economic risk in another way now, so we have looked at absolute return vehicles, which can generate 3-4% a year. One example is an M&A focussed strategy that has been benefitting from the resurgence in corporate activity – we do this via the BlackRock Event Driven fund.
In a world of rising inflation, trend strategies that can capitalise on rising commodity prices and yields have also been performing well; here we use the AQR managed futures strategy.
Frankly though, it is a harder world to invest in now.
