Cash shy
But what to do if you don’t feel comfortable keeping so much cash in your pocket? Considering the opportunity costs which come with holding a lot of cash, some investors understandably are exploring other ways to mitigate the risk of rising interest rates.
“We don’t consider cash an investment instrument in itself,” says José Luis Borges, head of institutional portfolios at Portuguese bank BPI Gestão de Activos.
“We may hold some cash as a short-term allocation and for liquidity reasons, when we don’t see many attractive investment opportunities, but we haven’t increased it in a meaningfulway recently.” Even though Borges, like almost all of his peers, has “not a positive view on bonds” at the moment, his cash weighting is only 5%. He is invested mainly in short-duration bonds with moderate credit risk in the fixed income part of his portfolio.
However, as avoiding interest rate risk is Borges’ prime concern at the moment, the biggest chunk of BPI’s fixed income portfolio is allocated to floating rate notes, which are tied to euribor and are mainly – but not exclusively – issued by banks. “We have doubled our allocation to these instruments over the past 12 months to 15% to 20% of our total allocation,” he says. To mitigate counterparty risk, BPI owns floating rate notes from between 10 and 15 different issuers, with a slight home bias. “About a quarter of these notes are from Spanish and Portuguese banks. They pay slightly more interest than northern European banks.”
Staffan Sevón (pictured left), head of tactical asset allocation at Finnish pension insurance company Ilmarinen, is not a fan of cash either. “We have a preference for the interest rate risk in bonds compared to the counterparty risk you have to take if you want to get a positive return on cash somewhere,” he says. “And in essence, currency and fixed income are two sides of the same coin. In the long run, the fixed income market will reflect the strength of currencies.”
So are floating rate notes, Borges’ favourite fixed income instrument, also Sevón’s investment of choice? Although unwilling to reveal exactly what he has been investing in to position Ilmarinen for a rate rise, he confesses: “Floating rate notes might work.”Although Sevón may be right in saying cash hardly returns anything, Ilmarinen’s bond portfolio, which makes up almost half of the company’s total investment portfolio, doesn’t either at the moment: it returned 0.8% in the first half of 2015, compared to a 14% return for equities.And with a Fed rate hike on the horizon,fixed income investing is certainlynot without risk. But Sevón realises that: “We look for opportunities with a negative correlation to interest rate risk.”
