Vinyl single records had two sides: The A-side was always the well-known hit song by the musician, and the other, called the “B-side,” was often a lesser known (or unknown) work. When it comes to cash management, the hit song on the A-side ‒ “Capital Preservation Is King”‒ has been played over and over since the financial crisis, amid episodes of stress and illiquidity, continuing central bank action and changing regulatory frameworks.
As monetary stimulus in the U.S. winds down, however, global investors need to consider turning the record over to the B-side and listening to a new tune for cash management: “Purchasing Power Preservation.” The prospect of the Federal Reserve raising interest rates is a harbinger of economic growth, and with increased growth comes an increase in inflationary pressure.
Until now, traditional cash management strategies – investing cash via money market funds, directly buying U.S. Treasury bills or placing monies on deposit with banks – have mostly succeeded in preserving capital. But they may have failed to preserve purchasing power: Their near-zero returns have trailed even recent modest levels of inflation. For example, regulated money market funds, the vehicle of choice for many investors, were yielding a mere 0.01% at the end of June, according to Crane’s Money Fund Index. Even a modest pickup in inflation in the coming months will make money market fund returns look inadequate as many fund yields will fail to recalibrate sufficiently higher even as rates across other assets and strategies begin to rise. The real cost to those who continue with traditional money market approaches will be negative returns after adjusting for inflation and failure to achieve the goal of purchasing power and capital preservation.
Ahead of the Fed’s rate actions and also the implementation of the Securities and Exchange Commission money market fund reform in 2016, we believe now is the time for investors to consider looking beyond money market funds toward active approaches for capital preservation. Alternatives, including low volatility short-term and low duration strategies, seek to preserve purchasing power, as well as capital, in an environment of increasing inflation pressures by investing in assets that may offer more yield and the potential for higher total returns in exchange for a minimal increase in risk.