Anthony Rayner
Premier Miton Macro Thematic Multi Asset Team
For information purposes only. The views and opinions expressed here are those of the author at the time of writing and can change; they may not represent the views of Premier Miton and should not be taken as statements of fact, nor should they be relied upon for making investment decisions.
Opportunity cost knocks
Last week we discussed the pitfalls of holding cash, despite high potential short term returns currently. We looked at how inflation erodes the value of cash, as a nominal asset, and how cash can often seem a sensible option, especially in moments of extreme uncertainty, but how that is often exactly the wrong time to hold material cash.
More generally, history shows that the opportunity cost of holding cash is normally very high. For example, cash rarely outperforms risk assets, such as equities and commodities on a consistent basis. In fixed income there are opportunity costs too, in terms of higher potential returns from taking some credit and interest rate risk. For example, the Bloomberg US corporate high yield index currently yields 9%.
So, holding material cash might feel like low risk but, as a single asset, provides no diversification and, over the long term, cash is the lowest returning of the major asset classes. So, whilst cash can be a useful asset, in moderation and on occasion, beware its pitfalls.
So, if not cash, what?
Well, there are many clients who have a lower risk tolerance, or a shorter term time frame, and they are understandably concerned about downside risk, but over the medium term they also need returns above cash and inflation. So, this week we look at an alternative low risk option which, unlike cash, is designed to preserve wealth.
Our starting point is to recognise that asset classes don’t behave in a consistent way in relation to their history, and also therefore in relation to other asset classes. They might well have extended periods when behaviour is consistent but change always comes, often when something dramatic occurs in the broader environment.
This creates two important conclusions when thinking about low risk investing. Firstly, investors shouldn’t rely on a single asset class, be it cash or anything else, as what is low risk today might not be low risk tomorrow. Secondly, if it’s accepted that the approach has to be multiple asset, not single asset, then that range of assets also needs to be run on an active basis, as the best low risk profile across multi assets will not be static.
For a good example of why both of these points are important, take 10 year gilts last year, when they fell 25% (inflation was the dramatic change in the environment that led to this perceived safe haven materially underperform equities). Single asset class low risk investors with an exposure to gilts would have been seriously caught out, as would the more static multi asset investors who see gilts as their “go to” low risk asset class.
In contrast, our approach to managing portfolios across risk levels is to be open minded about the behaviour of sub assets classes and to respond in an active manner if necessary.
As a recent example, the Premier Miton Defensive Multi Asset fund had minimal exposure to gilts last year, and what it did have was cash-like, i.e., very short duration. This pragmatic and active philosophy has been driving our approach for many years, and last year was no exception. This graph shows how active the fund has been, going back nine years to fund manager inception, just looking at duration, ranging from under 3 years to over 14 years in government bond duration.
Premier Miton Defensive Multi Asset fund: actively managing duration
Source: Premier Miton data from 30.06.2014 to 09.06.2023.
This approach of believing in the theory that asset class behaviour changes and then acting accordingly in the practice has contributed to the fund being about a third as volatile as the FTSE 100 Index over time and, perhaps more importantly, is the best in its sector in terms of maximum drawdown since fund manager inception. However, in order to preserve wealth, it’s not just about protecting the downside, low risk also has to take part in equity upside. The chart below shows how the fund has done this since tenure, compared to a cash proxy, over three year rolling time periods. It shows clearly that the fund is very rarely worse off than cash, and when it is minimally so, and very often considerably better off than cash.
Premier Miton Defensive Multi Asset fund performance vs cash over 3 year rolling periods since manager tenure – % total return
Source: FE Analytics data from 30.06.2017 to 31.05.2023 in Pounds Sterling. Past performance is not a reliable indicator of future returns.
In summary, we don’t see cash as lower risk than a low risk multi asset portfolio, principally because cash doesn’t consistently outperform other key assets, plus holding just cash doesn’t provide diversification. Instead, actively managing a range of multi assets, potentially including some cash, with an open mind and a willingness to be nimble, seems a more sensible way to go about wealth preservation over the longer term.
