Why investors need to rethink their cash positions: insights from Vanguard and BetaShares

It was the famous billionaire investor Ray Dalio who in 2020 famously and controversially claimed that “cash is trash.”

It might sound a bit ridiculous – particularly as Dalio later said that the trash claim did not apply at all times, only at certain junctures.

However, Dalio’s idea that cash is an inferior investment because its buying power is eroded by inflation is actually very sound in the long term.

That is particularly the case because retail investors often get less than ideal returns on their cash investments.

Australians invest a lot of cash

Looking at the potential underperformance of cash is particularly important in Australia because we are massive cash hoarders.

For example, Australian Tax Office figures show that self-managed superannuation fund trustees had a massive $145.9 billion in cash and term deposit investments at the end of December 2023, representing a very high 16.6% of total net SMSF assets.

Having that much cash in a portfolio in the long term can really be a big drag on the fund’s performance.

Cash beaten by bonds, property and shares

The Vanguard Index Chart which tracks the performance of major asset classes from July 1, 1993, to the end of June in 2023 showed that the average annual return in Australia from cash over that period was just 4.2%, compared to 5.5% from Australian bonds, 7.3% from Australian listed property, and 9.2% from Australian shares.

Determining how much cash to hold in a portfolio – be it inside or outside of superannuation – is often a function of the investor’s risk tolerance and their investing time horizon.

If you have a low risk tolerance and a short time horizon then cash can be a perfect investment but for those with a higher risk tolerance and a long time horizon, having too much cash in the portfolio is a recipe for underperformance and losing purchasing power due to inflation.

Make sure you get the best cash return possible

Another issue to consider is getting the highest return possible for the cash part of your portfolio, with term deposits and high interest savings accounts often producing lower “retail” returns and coming with some annoying conditions.

It is hard enough to keep track of investments without having to make sure you jump through hoops such as having a higher month end balance or making a certain number of transactions and deposits to make sure that your high interest account doesn’t drop down to a much lower rate.

Term deposit rates on offer at banks can also be quite low.

A new ETF can earn higher monthly income

Interestingly, local Exchange Traded Fund (ETF) provider BetaShares recently launched a very compelling product that effectively gives investors access to “wholesale” interest rates with monthly interest payments without adding a lot of risk.

Known as the Australian Major Bank Subordinated Debt ETF (ASX: BSUB), it is claimed to be the first pure-play Tier 2 bank credit fund in Australia and is already trading on the ASX.

It offers attractive income, paid monthly and invests only in high quality Australian denominated Tier 2 bonds issued by the big four banks.

It should also offer protection against rising rates with subordinated debt at the moment delivering around 1.8% above cash deposits and 0.9% above senior bank floating rate notes.

Indeed, the return on subordinated floating rate notes have been matching and in some cases surpassing the franked yields of the big four banks themselves but with a fraction of the volatility.

Part of the big and liquid bank credit market

Given that the $250 billion bank credit market is a well-established part of the broader Australian fixed-income landscape that has long enjoyed a lot of investor support due to the strength of our banking sector, that should make BSUB a highly competitive product for cash investors.

Of course, there are risks – which the very word “subordinated” alludes to – but for me the biggest risk is not being a little further down the pecking order for repayment, lying somewhere between senior debt and the less secure and more volatile listed hybrids and bank shares.

It is technically true that one or more of Australia’s big banks might get into serious trouble at some stage in the economic cycle, although that seems a fairly remote and unlikely possibility.

ETF may underperform the index a little

The biggest risk I see is that BSUB is not a true index fund because it can’t really buy the relevant Solactive index, with the fees and expenses on the ETF of 0.29% almost certainly producing a slightly lower return than the actual index indicates.

Still, that is very likely to be a lot better than the rates offered inside a bank for term deposits, which is not bad for an investment that produces monthly income payments and can be sold on the stock exchange and deliver you cash in a few days.

It will be interesting to see how BSUB goes but even at this early stage, it seems to be a very useful addition to BetaShares overwhelmingly popular and convenient Australian High Interest Cash ETF (ASX: AAA).

While AAA offers a slightly lower yield of 4.2% it also has monthly interest payments and has earned a position in many SMSF portfolios for those who are happy to let someone else run around to find the best cash deposit rates going at the major banks.