Where do we stand now and what can we expect?
At present, US dollar and euro short-term benchmark interest rates offer investors cash savings rates that have not been seen since at least 2007, at 5.5% in the US and 4% in the eurozone. Unsurprisingly, then, many investors retain a high proportion of their financial wealth in cash today.
Given that inflation rates are quickly cooling towards 2% in the US and Europe, we expect US and Eurozone central banks to begin reducing their benchmark interest rates from June onwards, continuing until at least the end of 2025.
Investors should not be seduced by the high interest rates of today, as these should fall from the middle of this year. Therefore, investors will likely receive far lower returns on cash deposits in future.
In such context, what proportion of a portfolio should be kept in cash?
We currently observe that some investors hold a high proportion of cash in their portfolio, either in money market funds or term deposits.
Our clients feel a sense of security with cash, but are they aware of the long-term investment risks associated with it?
- First, the cost of a reinvestment: as explained, cash deposits would receive probably lower income in the future.
- Second, the cost of inflation: over the last 10 years, cash has returned on average 1% less than the inflation rate both in dollars and euros. In other words, purchasing power of investors has decreased.
- Last, the cost of opportunity : while cash investments have provided a barely positive nominal return in euros on average over the last 5 years (+0.38% annualized), conservative portfolios have returned around 2% per year on average.
Liquidity is useful in a financial portfolio either to keep flexibility to take advantage of an unforeseen opportunity for example, or to provide short-term protection. However, due to the opportunity cost, we strongly advise our clients to keep only sufficient cash positions in their overall portfolio.
In most strategic asset allocations, cash is usually limited.
At BNP Paribas Wealh Management, whatever your investment profile, your exposure to cash generally remains below 10% of a total portfolio. Even for investors with very conservative profiles, bonds are favoured, possibly with a shorter maturity, and other investments instead of cash. So in view of cash rates expected to fall in the coming months, we recommend moving from cash into other asset classes to benefit from higher long-term returns.
Let’s talk about attractive opportunities!
What cash rate are we aiming to beat?
With central banks cutting rates this year and next, we believe that a reasonable income benchmark to beat is 4.5% per year over the next 2 years in the US, and 3% over this same period in the eurozone. Indeed, this scenario is an estimate based on current market conditions and is not an exact indicator. it can vary depending on how the market performs.
One of the simplest ways to lock in a better yield for longer is via short-dated investment grade corporate bonds.
Today, US short-term corporate bonds offer a 5.3% gross yield, while the equivalent Euro short-term corporate bonds carry a 3.9% yield.
For conservative investors, we also offer:
- Emerging market sovereign bonds
- European corporate bonds in the financial sector
- Asset backed security (ABS)
How to prepare for the environment of lower interest rates?
Our Investment Solutions experts will help you to build your portfolio allocation based on your performance objective, risk preference and time horizon.
- If you prefer to make your own investment decisions, advisors at BNP Paribas Wealth Management’s can partner with you to calculate an adequate cash exposure and provide you with advice, recommendations and solutions.
- Through standard or tailored mandates, our portfolio managers have already started to reduce the cash proportion, and shift into investments with a longer investment horizon.
- With typically 2% to 5% of liquidity in mandates, we monitor global markets on a daily basis, to seize the best market opportunities.
We identify a number of attractive income-yielding investments across asset classes, including shares, bonds, and alternative assets to offer our clients alternatives to cash deposits, our Discretionary Portfolio Management mandates and Advisory mandates already include asset classes with higher long-term returns, , taking into account your investment profile.
If would like to know more, please contact your relationship manager to set up a meeting with one of our financial experts.