Why investors are making a dash for cash

Money market funds represent an attractive return for risk-averse investors for the first time in years, financial analysts say

Cash returns look set to improve as the US Federal Reserve and other banks intensify the fight against inflation by raising interest rates. Getty

For a dozen years after the financial crisis, stocks and shares were the only game in town, as years of easy money sent asset prices to the moon and cash paid next to nothing.

Over the past 18 months, the investment world has flipped, with investors embarking on a “dash for cash” as interest rates rise, while shares struggle as inflation squeezes spending and growth.

The US may be enjoying a bull market but that has been driven purely by the hype around the artificial intelligence revolution, which now seems to have got out of hand.

Investors have been piling into the “magnificent seven” US tech mega-caps – Apple, Microsoft, Amazon, Google, Nvidia, Meta and Tesla – but strip them out of the S&P 500 and the index is up only 5.6 per cent this year, while hopes that the Chinese stock market will recover have floundered.

A growing number of investors are now asking why they should put their capital on the line amid today’s slim pickings when they can get 5 per cent or 6 per cent a year on cash deposits without taking any risks at all.

Cash returns look set to improve as the US Federal Reserve and other banks intensify the fight against inflation by raising rates even higher.

The Fed held its funds rate at 5.25 per cent in June but markets are now pricing in a 90 per cent likelihood of a rate increase at its next meeting on July 25 and 26, with its recently published minutes suggesting at least one further rise to follow this year, and possibly more.

It may be forced to tighten as the US jobs market continues to boom, with payrolls data repeatedly beating expectations, says Fawad Razaqazda, market analyst at City Index and Forex.com.

“Will that trend continue? If it does, interest rates will likely rise and remain higher for longer,” he says.

As far as equities are concerned, the best is already in for 2023, says Nadege Dufosse, global head of multi-asset at fund manager Candriam.

Emerging Asia may perform well but otherwise “restrictive monetary policies should continue to spread throughout the economies of developed countries, and inflation is likely to decelerate only gradually”, she says.

Saxo chief investment officer Steen Jakobsen says investors are “naive” about growth prospects while the AI hype has gone too far.

“The economy is currently loaded with excess debt and asset valuations are at all-time highs. A soft landing is very unlikely in this environment,” he says.

Many have responded to the changing environment by shunning stock markets and seeking safety in cash and money market funds, which offer a portfolio of short-term cash deposits, money market instruments and high-quality bonds, according to Tom Stevenson, investment director at Fidelity International.

“As interest rates rise, money market funds represent an attractive return for risk-averse investors for the first time in years,” he says.

They appeal to investors who are concerned about market volatility, saving for a short-term goal or looking for somewhere to park their cash while deciding where to invest next, he adds.

Yet money market funds could make a poor long-term investment as Mr Stevenson suggests that “returns have lagged behind shares and bonds over more extended periods”.

Laith Khalaf, head of investment analysis at fund platform AJ Bell, says cash and money market funds may look attractive today but history shows that over the long run, stocks remain the better bet.

“Barclays has analysed UK investment returns since 1899 and found that over a 10-year period, shares beat cash 90 per cent of the time,” he says.

Jason Hollands, managing director at fund platform Bestinvest, says while higher interest rates are a headwind for equities, cash still pays less than inflation, eroding the value of deposits in real terms.

“Cash looks superficially attractive but holding too much for long periods will only make you worse off over time.”

With cash, savers only earn the headline interest rate while shares offer both capital growth and dividend income, which compound to deliver a superior total return over time, Mr Hollands says.

Instead of hiding in cash, he advises savers to increase their exposure to bonds, where yields have been rising strongly.

In the US, two-year Treasuries now yield more than 5 per cent a year while two-year UK gilts yield about 5.5 per cent.

While two-year fixed-rate savings bonds may offer a slightly better return, you cannot access your money in that time, he says.

“In contrast, you could sell your bonds at any time if you need some cash.”

Rather than buying individual government bonds, investors can have access to a spread of them through an exchange-traded fund such as the Vanguard Total Bond Market ETF, which focuses on investment-grade US bonds and with a trailing 30-day yield of 4.4 per cent.

Mr Hollands suggests we may soon reach “peak cash” as central banks in the US, the UK and Europe approach the end of the current tightening cycle.

“Interest rates are likely to fall next year as inflation abates and these economies sink into recession caused by aggressive policy tightening,” he says.

As interest rates rise, money market funds represent an attractive return for risk-averse investors for the first time in years

Tom Stevenson,
Fidelity International's investment director

When that day arrives, returns on cash will fall while lower borrowing costs should revive stock markets.

Mr Hollands is also wary of AI hype and expects Asia and emerging markets to lead the stock market recovery.

Today, he tips lower-risk sectors such as health care, consumer staples and materials as the economy looks set to struggle for a while longer.

Cash is back and about time, too. Savers have had a rotten deal for years and it is good to see the imbalance redressed.

But investors should not give up on shares yet. At some point, later this year or in early 2024, they are expected to flip back into favour, and those who are brave enough to buy them today will be rewarded when they do.