Managing a Shift in the Risk-Return Relationship: Cash Management & Fixed Income

June 9, 2020

Our last investment webinar addressed risk tolerance from a trustee’s perspective. We assessed the shift in risk and return dynamics during Q1 of 2020 as a consequence of the COVID-19 pandemic which we went on to define as a ‘white swan’ event that had reshaped the investment landscape.

In our second webinar of the series, we will explore in greater detail the impact on cash and fixed Income as asset classes, and we will assess how returns have been significantly impaired whilst the associated risks have increased.  

Cash Management

For a decade, trustees have had to weigh the benefits of being invested in markets or sheltering in cash management solutions. Whilst we all thought interest rates were low, it was still possible to earn around 2% on a fixed term deposit in USD or GBP, which would keep up with inflation and preserve capital for the long term. For a few years now, any trustees with exposure to euros have faced the challenge of zero return on cash; all depositors are now in the same position.

Should trustees accept a return of zero?

Over the medium term, the capital erosion from fees and the reduction in purchasing power through inflation will mean some difficult decisions will need to be made.

We will look at current cash management solutions to see what rates can be achieved and will look at various options to diversify counterparty risk.

Yes, liquidity is more important than ever in volatile market conditions and when the economic outlook is increasingly uncertain. Are we back in the position of needing counterparty diversification to protect against a risk of a banking crisis? In our first webinar, we touched upon the legacy of debt at household, corporate and government level. During this webinar we will take a closer look at the health of financial institutions in the US, Europe and Asia.

Path Analysis

We will discuss four scenarios for the global economy (illustrated below) to assess the possible direction of travel for the current low interest rates, and we will look at potential paths for economic recovery with or without a vaccine.

If there is no predefined shape to the global economic recovery, it can be useful for trustees to consider the recovery (R) and vaccine (V) factors to assist in assessing the global economic path.  

Whether a trustee and their clients are bullish or bearish about the future, they should be planning for each scenario to preserve and, where possible, grow capital for future beneficiaries.  

Fixed Income  

One of the most challenging scenarios is within fixed income where we have seen some dramatic shifts in yields and credit ratings.

The second part of our webinar will look at government, corporate and high yield bonds. We will firstly discuss how the returns from sovereign debt now represent a ‘risk-free’ rate of near to zero; we will then look at how corporate debt is graded by the ratings agencies; and we will finally go on to consider the boundaries and distinctions between investment grade bonds and junk.

Whilst not wanting to overstate an old investment truism - one finds out who is wearing trunks when the tide goes out. If we have just experienced an economic tsunami in Q1, we are starting to see the waters recede and the view is revealing some corporate entities with very little to cover their modesty (some may have received government issue briefs).

One of the most remarkable features of Q2 so far has been the Fed purchasing Corporate Bond ETFs. We will be unpacking this dynamic of government interaction with markets to see what impact this could have for investors.

The pursuit of rate-hunting by trustees is becoming more perilous and requires closer analysis and a better understanding of current yields, yields to maturity, duration and the inverse relationship between bond prices and yields. In the final section of the webinar, we will be taking a closer look at these features of bond markets.

In our open mic Q&A session, we will be discussing the level of risk trustees should be willing to take for a marginal increase in returns and will consider realistic expectations for returns from cash and fixed income asset classes.

We hope you can join us for the second in our series of investment webinars, click here to register.

Disclaimer: The views, thoughts and opinions expressed within this article are those of the author, and not those of any company within the Capital International Group (CIG) and as such are neither given nor endorsed by CIG. Information in this article does not constitute investment advice or an offer or an invitation by or on behalf of any company within the Capital International Group of companies to buy or sell any product or security.

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