Merit in paying for safety of cash

Recently I espoused the benefits of cash as a component of a client portfolio. Yet with government debt issuance at negative yields – Sweden’s two-year at -0.20 per cent almost feels like a watershed in our expectations for “safe haven” assets – and the ECB’s rate cuts (notably the deposit rate to zero per cent), cash is close to becoming a zero, or negative, return asset.

This has many implications, but the one I will highlight here concerns cash funds – many of which, as we have already seen, are closing to new business because they are worried that they cannot avoid “breaking the buck”.

My Bloomberg news ticker has numerous stories about Euro-denominated money market funds closing to new business, as financial institutions realise that, without waiving fees and potentially subsidising costs, investors will see a negative absolute return. With over €100bn in Euro money market funds, according to Crane Data, this is a significant market event. Back in the financial crisis of 2008, the notion of “breaking the buck”, and the understandable desire to avoid it, led many companies to drastic action.

Many of these funds owned SIVs (special interest vehicles, now a dirty word in investment circles) whose sudden illiquidity as financial markets seized up, combined with the associated mark-down in value, led some – but not all – institutions to either move these investments onto their balance sheets, or to guarantee them within funds, rather than risk investor capital loss. While such sentiments make sense in environments accustomed to positive interest rates, I wonder whether we need to re-evaluate our expectations of cash funds in the current environment.

We invest in cash funds, rather than leaving our cash at a bank or custodian for two primary reasons: the hope of a better return and for increased expected safety through diversification. In the current low rate paradigm, the former might theoretically be true but the difference is negligible. It is on the second factor that, particularly in a world where banks are no longer considered safe, we should focus our attention. I would argue investors should consider the possibility that paying for this increased safety might not be such a bad idea. In fact, investment theory teaches us just that – higher risk assets should pay us a risk premium, and so it follows that lower risk assets might actually incur a cost.

Taking this discussion to an individual level, many of us have a so-called “premium” bank account (generally an excuse for the bank to charge us for various benefits we neither want nor need), which often essentially means a negative return on our bank account (that is, any interest paid does not offset these costs). Generally we seem comfortable with this, and while the British government notionally guarantees our deposits, albeit not infinitely, those with a modest current account balance could argue that they are “invested” in a safe park for cash. However, we are paying for this, and while theoretically safe we are certainly not diversified.