The potential rewards from generating improved returns on clients’ cash are huge, says Giles Hutson, but while competition in this part of the market may be improving, the psychology surrounding cash still needs to change
This dislocation between the equity and fixed income markets means many advisers are recommending clients take some ‘chips off the table’ and increase the percentage of their investment portfolio held in cash. I was recently presented with a balanced portfolio with a suggested cash allocation of 8% while, for a defensive portfolio, it can be as high as 20%. These percentages continue to creep up as the valuations of other asset classes increase.
But this is only half the story. In many cases, advisers only get to see part of the overall picture. Clients often treat their cash separately from their investments which, day-to-day spending aside, does not help anyone. How can an adviser give proper objective advice without seeing the full picture of a client’s finances?
In most cases, clients sit on this cash in a high street bank account – probably one they have held for many years – earning little or no interest. When these paradigms are combined, a client could have as much as half their savings in cash and it is highly likely this cash is underperforming.
Clients must be encouraged to share the full picture of their finances with their adviser but, for this to happen, the financial services sector needs to get much better at offering cash investment alternatives.
Very few advisers offer cash investment products and, if they do, they are often structured notes. The principal may be protected but any return is actually exposed to the risk of interest rate or currency fluctuations. Suitability is often also an issue – these investments require a level of sophistication that is inappropriate for the majority of investors.
For a lack of better options, cash and short-dated bonds are often confused. Not only do they behave in very different ways but, right now, the two-year UK Government bond yields less than half a percent while the best two-year bank account yields 2%.
The bond is more liquid but the client can earn nearly four or five times the return with the bank. In addition, if the amount of cash with any one bank is £85,000 or less, then the bank deposit is Financial Services Compensation Scheme-eligible so the risk profile would be very similar to gilts.
Cash may not be the sexiest asset class but all adviser clients hold it. It should be viewed as part of a portfolio – not an afterthought. Cash returns need to stop dragging down the overall portfolio returns.
Better cash alternatives can give advisers the confidence to advise a client to sell and recommend cash as an asset class with less concern about ‘missing out’.
Active cash management is important at any stage in the cycle but arguably even more so in the current interest rate environment. The recent rate rise from the Bank of England is a helpful start but it will not make a meaningful difference to savers.
There are two factors that will have a greater impact on their returns – increased competition in the banking market, and overcoming the inertia around cash management.
Regulatory change, the growth of challenger banks and developments in technology are improving competition but the psychology surrounding cash needs to change. There is an estimated £1.5 trillion of “inert” cash in the UK right now. If people make the most of the more competitive banking environment to improve their returns on cash by just 1%, this could release £15bn back to investors and ultimately back into the UK economy. The potential benefits are huge.
As featured in the Professional Adviser