While some financial advisors’ more adventurous clients are beginning to dip their toes into longer-term investments such as equities, balanced funds and bond funds, cash is still king in the investment landscape.
Burnt by the traumatic events of the past two years, including the implosion of the asset-backed commercial paper market, subsequent credit squeeze and stock market collapse, scarred investors are making capital preservation a priority, hiding out in safe, interest-bearing investments that pay paltry returns and offer little chance of growth.
Investment Executive’s research for the 2009 Report Card series shows that advisors’ revenue has tilted more toward banking products such as guaranteed investment certificates and high-interest savings accounts in the past year, while equities and mutual funds have lost market share.
“With so much uncertainty and fear lingering in the air, many people are content simply to hang on to what they have, and would rather keep it than lose it,” says fund analyst Dan Hallett, president of Windsor, Ont.-based Dan Hallett & Associates Inc. “Bank deposits can look damn good at times, and don’t require having to pop the Rolaids. These attitudes emerge in bear markets, and what we’ve been through has been worse than the average bear. But while the flight to safety is typical behaviour, it can be short-sighted.”
A recent report by Toronto-based CIBC World Markets Inc. reveals that the mountain of excess cash on which Canadian investors are sitting is now $120 billion higher than normal levels. A year ago, Canadians were sitting on $45 billion of extra cash; at that time, CIBC World Markets senior economist Benjamin Tal had described it as “excessively cautious.” The size of the cash mountain has almost tripled in the past year, with most of that cash sitting in liquid investment vehicles such as money market funds, GICs and bank accounts.
“Cash levels were huge a year ago; now they’re even bigger,” Tal says. “Investors went through a major shock, and they are scared. It’s all about risk aversion. The Canadian market has come back 40% from its lows, and people are still scared.”
The hoard of cash will ultimately be moved to areas in which returns are better, Tal says, and he expects the stock market to be a major beneficiary by 2010. He says the extra $120 billion in cash amounts to about 8% of the market valuation of the Toronto Stock Exchange — the highest percentage since 1997.
“Although many people tend to sit on their cash too long and miss part of the recovery, there is a lot of pent-up potential for the stock market,” Tal says. “And much of this money will find its way back to equities.”
Tal says the “liquidity bubble” is not evenly distributed, and most of the excess cash is sitting in the pockets of those 50 to 65 years old. Unlike investors in younger age groups, who are saddled with higher debts and mortgages to which they could apply their excess cash, this older cohort has largely paid off their debt, Tal says, and their elevated cash loads are more likely to find their way into securities such as stocks as the fear subsides.
“The next question is, ‘Where will the money go?’” Tal adds. “The days of bond market outperformance are numbered, with the U.S. printing money like there’s no tomorrow and laying the groundwork for future inflation and rising interest rates. That leaves real estate and the stock market, and real estate is not looking sexy enough right now. Equities will ultimately attract money as people go for the blue-chips and high dividend-paying stocks; the risk-averse will initially head to the solid, established large names.”
Even among the short-term, liquid investment alternatives for cash, investors’ tastes are beginning to change. The latest statistics released by the Investment Funds Institute of Canada show that investors have become disenchanted with money market funds, and redemptions have risen within the past few months. During the past two years, money market funds had a net inflow of $19 billion, but this flow has turned negative, switching to redemptions of $2.8 billion in June. The stampede accelerated to $3.3 billion in July.
The problem is that interest rates have fallen so low that these funds are not making a return after fund management fees — even though many fund sponsors have reduced their fees. Instead, much of this money is finding its way into high-interest savings accounts that offer comparably higher rates.
@page_break@“On the cash side, money market yields have dropped dramatically, and deposit vehicles are more attractive, particularly high-interest savings accounts,” says David Richardson, vice president with Toronto-based RBC Asset Management Inc. “There’s more cash than we’ve ever seen searching for a safe yield.”
RBCAM’s high-interest savings account currently pays an annual interest rate of 75 basis points, which is low by historical standards but more than twice the 30 bps RBCAM’s premium money market fund currently offers, Richardson says. The high-interest savings accounts are also appealing because of the Canada Deposit Insurance Corp.guarantee and the easy liquidity these accounts provide.
Figures provided by Toronto-based Investor Economics Inc. show that at the end of 2008, $120 billion was sitting in high-interest savings accounts, up by 29% from $93 billion a year earlier — and the popularity of these accounts is increasing. Although GICs continue to attract money, clients must be willing to lock in — and few are willing to go long-term.
“The challenge that fund companies are facing is that much of the short-term money is going to deposit-taking institutions,” says Iassen Tonkovski, senior analyst with Investor Economics. “Fund companies are having difficulty delivering on yields on money market funds in the low interest rate environment, and investors are looking elsewhere.”
The problem with investing in interest-paying securities at today’s low rates is that investors are barely making a return after taxes and inflation, and could actually be losing ground. Although money market funds and deposits offer capital preservation, that will not likely be enough to allow investors to meet long-term objectives — thus, clients will begin to seek greater exposure to assets offering growth.
Some are already taking steps in this direction by heading to products with exposure to equities that come with guarantees, including segregated funds offered by insurance companies and guaranteed “target date” funds offered by IA Clarington Investments Inc., Bank of Montreal and Mackenzie Financial Corp. Seg funds with guaranteed minimum withdrawal benefits or income guarantees have also soared in popularity.
These products come with higher fees than regular mutual funds, but many investors are happy to pay in return for protection while participating in the equities market upside. To receive the principal guarantees, investors must typically hold these products until a predetermined maturity date. IE’s research confirms a strong increase in advisor revenue from seg funds this year, while revenue from other insurance products, such as life insurance, has dropped.
Strategies that involve diversifying across an assortment of securities and asset classes, either by assembling a balanced portfolio holding a mix of stocks, bonds or cash — or by investing in prepackaged fund “wraps” — also appeal to clients who remain cautious but are still willing to venture further along the risk curve to make a better return. This approach offers diversification across various asset classes combined with regular rebalancing back to the original asset mix as markets shift in value, which tempers portfolio volatility.
Richardson says RBCAM has just experienced the best May/June period it has ever had, in terms of long-term fund sales. Portfolio funds represented the lion’s share offered through Royal Bank of Canada retail branch locations, while stand-alone fixed-income funds were most popular in RBC’s brokerage channel, Toronto-based RBC Dominion Securities Inc.
“Investors recognize that to get growth, they must have exposure to various asset classes, including equities,” Richardson says, “and [they] appreciate that portfolio funds are a good way to do this.”
He adds that because of automatic rebalancing, those who had been invested in portfolio funds before the markets dropped last fall were better protected than investors who allowed rising equities to make up a disproportionate amount of their asset mix and thus were more vulnerable when the bear market took hold.
IFIC statistics point to a return to balanced and bond funds, which are on the more conservative end of the spectrum of long-term funds. In July, IFIC reported almost $1.8 billion in net sales of long-term funds, following $2 billion in net sales in June — the highest level seen in the month of June since 1997.
In July, $747 million of the long-term fund sales came from fund-of-funds products, and $1.1 billion each from the bond and balanced fund categories. Equity funds remained in redemption overall.
IE
Readying for shift to long-term investments
Those surveyed for this year’s Report Cards report that much client money is parked in bank accounts and other safe products (includes chart)
- By: Jade Hemeon
- September 1, 2009 October 28, 2019
- 10:24