Commentary: Why investors seeking a sweet spot between yield and liquidity should consider cash management products

Here’s a scenario that young investors might be familiar with: Your monthly salary has just been credited to your bank account and after factoring in expenditures, you are left with a tidy sum of cash.

One option you have is to invest a portion of the money. Logging in to your stock brokerage account, you are, however, confronted by a sea of red. Some say it’s a good time to buy the dip — but you may also end up catching a falling knife.

Ultimately, you decide to leave your money sitting in your bank account.

Investors are always holding on to some cash, no matter which phase of the market cycle they happen to find themselves in. For example, they may need to save for future expenditures, such as a home purchase or wedding expenses.

But when the markets feel like a rollercoaster ride, many investors instinctively choose to hold more cash as they await clearer signs of a recovery — or at least some semblance of stability.

WHY CASH MANAGEMENT IS ATTRACTIVE AGAIN

Under such circumstances, cash management solutions — the dullest of instruments at other times — suddenly seem attractive.

Offered mainly by brokerages and investment platforms, cash management products invest in money market funds or short-term government and corporate debt, or a portfolio of such assets.

With inflation at record highs, deploying capital into cash management solutions may seem counterintuitive. Singapore’s core inflation rose to 5.3 per cent, year-on-year, in September. 

This outstrips most cash management solutions, which are currently offering between one per cent and 3.5 per cent in expected yield, depending on their risk-return profile.

But for investors who are taking more of a risk-off stance in view of current market conditions, the alternatives to cash management solutions may well be lower-yielding or less flexible instruments.

Bank fixed deposits tend to offer slightly lower rates, while requiring funds to be locked up for longer periods — which may not be an enticing proposition for young investors who are concerned about liquidity.

Cash management solutions, by contrast, are highly liquid, with most allowing withdrawals at any time — although, unlike bank fixed deposits, returns are non-guaranteed.

High-yield bank savings accounts offer similar returns to cash management solutions, but they often come with conditions that may be challenging to meet, such as a minimum monthly credit card spend.

PICKING THE SOLUTION THAT SUITS YOU

Supposing you’ve decided that you would like to invest in a cash management solution. Your next task is to choose from a fairly diverse field of products.

For a start, investors need to examine the underlying assets in a cash management portfolio, which affects attributes such as risk, volatility and returns.

Cash funds, for instance, typically invest in fixed deposits available to institutions. Among cash management products, cash funds are on the safer end of the risk-return spectrum.

Money market funds are accompanied by slightly more risk. They invest in treasury bills and other high-quality short-term securities.

Ultra-short and short duration bond funds buy into investment-grade, short-term government and corporate debt. Such funds carry the highest risks among cash management solutions and also offer the highest potential return.

Cash management solutions can be invested in one of the fund types above, or a mix.

Next, investors should take a look at the quality of the fund manager and the fund’s assets.

Does the manager have a good reputation and a proven track record over a number of market cycles? Is it managing several funds? How large are these funds, and how have they performed?

In addition, the fund manager should also be able to provide information on the average weighted credit rating of its portfolio — which might be AA or A or BBB, for example. This helps investors understand the quality of assets and the risk they are taking on.

Third, pay attention to the fine print.

A cash management portfolio that holds more cash and money market funds might list its investment objective as “capital preservation”. This means you are less likely to suffer a drawdown or a loss to your principal sum.

Some funds may even guarantee capital protection. The trade-off is that the projected returns on such a portfolio will be lower — likely between 0.5 per cent and two per cent, based on current rates.

On the other hand, a portfolio with a larger proportion of short-term bond funds might have “capital accumulation” as an investment objective. This means investors can expect higher returns, likely between two per cent and 3.5 per cent currently.

But investors must bear in mind that if your withdrawal happens to coincide with an untimely drop in the fund’s net asset value (NAV), your investment return might be negative.

Management fees and how they are charged will also affect yield.

Investors often face two layers of fees — fund-level fees paid to fund managers, as well as fees paid to the financial institution curating the cash management portfolio or distributing the funds to end investors.

The first level of fees is usually accounted for in the NAV of the fund. But investors may well need to think about the second layer of fees when calculating returns.

For example, if a cash management solution has an expected yield of two per cent per annum and the financial institution distributing the product charges an additional one-time fee of 0.15 per cent, the expected yield over an investment period of one year would be reduced to 1.85 per cent.

EVERYTHING IN MODERATION

Cash is king, as the saying goes, and it is true that there is always a place for cash in your portfolio — if only to guard against an emergency.

The question is, how can you make your cash work harder and go further, while retaining the liquidity of that cash?

At a time of heightened market fluctuations, if one is planning to hold more cash in the short term — whether to ride out the volatility, to save for an upcoming life milestone or simply to wait for a more suitable investment opportunity — cash management products represent a sweet spot between liquidity and yield, with room to accommodate individual risk preferences.

But the adage “everything in moderation” applies even to something as safe as cash.

Having the bulk of your wealth in cash is risky in the long term because your portfolio will inevitably shrink in value over time, as the prices of goods and services rise at a quicker pace thanks to inflation.

For young investors with a 40- to 50-year time horizon on investing, that shrinkage is magnified.

It is wiser to practise portfolio diversification and allocate your capital across investment instruments with different risk-return profiles.

This approach gives young investors the best chance of achieving real capital gains and thereby boosting their retirement adequacy.

ABOUT THE AUTHOR:

Oi-Yee Choo is CEO of ADDX, a Singapore-based digital exchange for tokenised securities.