An Alternative to Cash?

A question many people are asking at the moment is, “where can I put my money when cash is returning so little”?

Well the answer is pretty limited… For investors not wanting to take any risk, fixed term deposits are the ideal place, however with the best rates at around 2% per annum it is hardly a viable option for those trying to match liabilities or at least beat inflation at 3%. 

Investors are being forced to take more risk than they would prefer.  So let’s look at the alternatives.

• ·         Fixed Interest/Bonds – these will offer little more than cash at the moment, government debt is yielding around 2%, and investment grade corporates are not much higher.  High Yield will be your best alternative at around 5-6% per annum.  With yields at record lows, long duration funds will be very sensitive to interest rate rises.  Therefore I would be fairly against this option, unless you can access short duration funds, such as AXA U.S High Yield Short Duration Fund.
• ·         Equities – there are a number of high yielding equities out there, however this is a risky option.  A number of UK equity income funds yield above 4% per annum, with some up towards 6-7%.  This option has the potential for added capital growth as well.  If you are looking to go for this option, more defensive funds such as Troy Trojan Income would be my choice.  This has excellent performance over the long term with a relatively low volatility.
• ·         Absolute Return Strategies - whilst these do not provide an income this may be suitable for those who do not require liability matching.   Absolute return strategies aim to provide absolute returns over the medium to long term.  Typical return aims are LIBOR + 4-6% per annum.  This is not as secure as holding cash however downside risk is fairly low as a multi asset approach is combined with derivative strategies.  This sector has been growing as more people seek alternatives to cash, it also acts as a great diversifier in any investment portfolio.   A number of examples are Standard Life’s Global Absolute Return Strategies which is now over £20bn in size, Insight’s Absolute Insight Fund which is a combination of absolute return funds offering a more diverse holding and Newton Real Return.

This hopefully provides you with a few alternatives to cash, but the reality of it is, until interest rates increase, more risk will have to be taken to obtain returns.

Portfolio Hedging - not for the Faint Hearted

When it comes to investing you generally take a long position(betting prices will rise).  But what happens if the markets crash, how can you protect your portfolio from heavy losses?
One of the most common ways, without selling your holdings is apply a hedged position.  A hedge is where you make an investment to reduce the adverse effects of a negative price movement. 

A great example would be during the credit crisis. If you had a heavy exposure to banking stocks you would have been hurt badly.  However, hedging that position by going short the overall index they resided in, or that direct position would have covered the losses.Hedging is not for the faint hearted and passive investors.  You will need to actively follow your position and implement strategic timing for the fullest effect.

There are many different methods of hedging a position.  A majority use derivatives to execute, however they can be accessed by retail investors though the use of exchange traded funds (ETF).  By taking a short position(betting that security will decrease) you can fully hedge your long position or partially hedge it if you wish to reduce the volatility. 

I mention reducing the volatility; by implementing a short position it will reduce the movement your portfolio makes either up or down.  During times of uncertainty, people use hedging to reduce the downside risk, investing long term after all is down to protecting your losses and maximizing your gains.

You can purchase a volatility index, most notably is the VIX index, this will provide protection in market crashes and if any geopolitical event occurs.  The VIX is currently very cheap as people have come to terms with Eurozone risks and changing monetary policy.

Another merit of using a hedge over selling the position, is due to the nature of derivatives, you can leverage that position allowing you to protect a larger proportion of your portfolio with one holding.  An easily accessible leveraged trade is Soc Gen 5 x leveraged short ETF. 

So next time you go to sell all your shares when you think the market may correct slightly, think again, hedging is always a possibility!