SHORTER-TERM MONIES, WHAT ARE YOUR OPTIONS?
Cash: either held in one bank, diversified across a few banks, or invested in a diversified cash fund. The interest rate is unlikely to be much more than that of the Bank of England base rate which means that your capital value will steadily erode over time, even with very low levels of inflation. Whilst interest rates could possibly even rise as early as 2022, they have a long way to go before they produce a meaningful return. However, one holds cash in exchange for certainty: “the return of my money”.
Short-dated government bonds: unfortunately, there is almost no benefit to holding a portfolio of short-dated government bonds. You are probably better holding cash as your yield is the same and your capital is more secure.
Short to medium term corporate bonds: this is certainly an option for some. The yield and real return on a portfolio of 3-year bonds is more attractive than cash but here the dynamics are starting to change and your risk profile is rising. Firstly, you need significant scale to build a well-diversified corporate bond portfolio, as it is important to avoid the risk of a default. Secondly, there is always the possibility – albeit remote – of liquidity drying up and not being able to sell your holding when you need to.
A classic corporate bond portfolio with a range of maturities, both long and short: again, this might well be a sensible option as long as one is aware of the risks noted above which are, of course, greater given the additional yield you are likely to achieve from investing in longer dated issues. A typical corporate bond portfolio today could yield as much as 3.1% with a duration of 8 years. Certainly, a step up from cash, but your capital in this portfolio could be hit hard if interest rates rise unexpectedly.
A multi-asset reserves portfolio: this is predominantly made up of government and corporate bonds, but probably diversifies into other assets such as equities and alternatives to provide additional return. The Sarasin Income & Reserves strategy aims to achieve inflation (CPI) +1% over an 18 month to 5-year period. However, should interest rates rise unexpectedly, the impact of a simultaneous bond and equity sell-off would be painful.
A target return portfolio: a slightly different approach to multi-asset investing is to target a specific level of return (e.g. inflation +2%). This could be achieved with a multi-asset portfolio, but one which carries a bit more equity risk combined with the judicious use of portfolio insurance (to help protect capital values in the event of a market sell-off). The portfolio is actively managed to try to avoid downside risk. This has worked well in the past and with volatility having fallen back (the VIX is at 15.1) portfolio insurance today is reasonably inexpensive. Two important points to make here: you are placing significant faith in your manager to move nimbly in the marketplace, and you certainly need a slightly longer timeframe for this portfolio. This strategy can work well if you allocate more to a cash portfolio than you might have done previously and then agree to place some funds in a target return portfolio which carries more risk but should deliver a better return over time.
