The Reserve Bank cut the repo rate by 2.75% in 2020, to a long-term low of 3.5%. As a result, money market returns will be materially lower than investors have previously experienced. Investors seeking positive real returns should speak to their financial advisor.
Over the years we have witnessed several investors inform us of their savings account in the bank, essentially cash, and during the mid 2015 to early 2020, South African investors could invest in money market (cash) and earn an attractive real return with little risk to their capital. Coinciding with poor local equity and property returns over that period, investing in cash was a highly attractive asset class for investors.
It’s pivotal that cash investors are aware of how their returns are generated, money market returns are largely dependent on the repo rates. The repurchase (repo) rate is the key monetary policy tool used by the South African Reserve Bank (SARB) to control inflation. As the repo rate rises, returns from money market investments also rise, and vice versa.
Central bank action post the GFC and now again post COVID-19
To re-stimulate economies post the Global Financial Crises, GFC, central banks around the world, including the SARB, anchored interest rates at record low levels.
In the subsequent years, money market returns fell to levels where investors were guaranteed negative real returns, encompassing the first half of the last decade. This was because policy makers were more concerned about stimulating economic growth at the expense of wanting to contain inflation, which interestingly never materialized. And now history is repeating itself.
In response to the devasting consequences of COVID-19, Central banks around the world have once again responded by cutting interest rates to record lows (in some countries interest rates are at zero or negative). The Monetary Policy Committee (MPC) of the South African Reserve Bank has acted similarly, by announcing two 100-basis points cuts, a 50-basis point cut and a further 25-basis point cut in the repo rate in 2020.
These actions have reduced the repo rate to 3.5%. They were also the first moves of more than 25 basis points by the MPC in many years, illustrating the seriousness with which they viewed this crisis. Given what we have observed above, we can therefore expect the average money market fund return to trend towards 3.5%.
Cash turning to trash
Investors will need to look beyond the perceived safety of money market funds to deliver attractive real returns. We say “perceived safety” because cash will increasingly prove to be a poor investment in preserving the purchasing power of your money over the longer term.
You will note from the chart below that over the last 10 years many components of inflation (electricity, health costs, education and petrol) have increased by more than the return achieved by the average money market fund.
So, anyone invested in the average money market fund would have been spending a greater portion of their income on these necessities, which they would have had to subsidise from other sources (if possible) as their money market fund investment has not kept pace with these increases.
Investors will need to look beyond the perceived safety of money market funds to deliver attractive real returns.
Importance of proper advice
Still many investors are unaware of the unintended consequences of investing in cash, and without proper advice they are losing money.
Typically, retired clients are invested in risk averse portfolios, consisting of significant cash holdings. As we were made aware of the repo rate changes, we have pushed the message that those clients should switch out of the risk averse portfolios and into more suitable blended portfolios that would generate real returns while managing downside risk.
Conservative investors with an investment time horizon of greater than one year need look no further than the Resolute Wealth Living Annuity Blend Portfolio. This blended portfolio consists of a weighting of 75% Conservative and 25% Worldwide. This gives protected exposure locally, protecting investors from market downswings, as well as focussed offshore equity exposure, to protect them from a depreciating rand over time and to enhance capital growth. In this way, the portfolio is more stable, allowing the returns to compound at a steady rate.
The below graph depicts the comparison in returns if an investor was to invest R100 into cash/ money market (Red line) vs R100 in the RWM Living Annuity Blend (Blue line).
Source: Morningstar
In conclusion, the RWM Living Annuity Blend’s defensive yield of around 12% with the potential for some capital uplift is attractive compared to cash rates of 4%, which will be no place to hide!
*Certain pieces were taken from Ninety One’s Cash trending towards trash article. We believe it has interesting perspectives for our clients.
