| Where cash is king, security follows |
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| The benefit of hindsight proves that no one can accurately predict the future – and in times of uncertainty cash is king. Depositors are now in high demand as banks compete for money and the market pricing reflects this. Establishing your level of risk aversion and acting on the basis of that is key says Jimmy Doyle. |
The words of the late Charles Haughey were turned into an acronym by Conor Cruise O’Brien to describe the strange happenings in political Ireland of the 1980s. That famous acronym GUBU is equally appropriate to describe the even stranger happenings in the global financial markets of the last few months. Grotesque, unbelievable, bizarre and unprecedented easily describes the state of the money markets for some time now.
A global government response
However, the Irish Government’s response to a deteriorating situation at home, which saw the possibility of an Irish bank being unable to meet its obligations and perhaps even a collapse of our banking system, has, it seems, managed to steady the storm. The Government’s decision to guarantee the liabilities of the six Irish owned banks and then to make the guarantee available to foreign owned banks with a significant retail presence in Ireland to take up should they wish, has been broadly welcomed as needed to reinstate stability and certainty in the Irish banking sector. While the scheme does not suit all banks operating in Ireland, it certainly has its merits. | | Jimmy Doyle |
These most recent events at home and abroad are just the culmination of the global banking crisis that became public knowledge some 18 months ago. This crisis actually began some years ago with the advent of subprime lending in the US. This was an accident waiting to happen and was predicated on house prices continuing to rise and rise. When the US economy and property prices slowed, the house of cards came tumbling down.
As the days go by, there are signs that the crisis is beginning to abate. The move by various governments to follow the Irish lead and put their own versions of the bank guarantee scheme in place is very welcome. There are perhaps many varieties of this scheme and it looks like the simplicity of the Irish one may be overtaken by the part nationalisation that we see in other jurisdictions. In the UK, the Government’s capital injection has gone a long way to restoring confidence in the UK banks and their operations in Ireland. No doubt, the Irish Government will move in this direction if the Irish banks look to be less well capitalised than their European counterparts and business suffers accordingly. Tier one capital ratios are settling around 9 per cent across the industry and this will become the benchmark. The various national guarantees are beginning to restore trust among banks dealing with each other in the interbank market. Now the recent concerted move by a number of the world’s central banks to reduce interest rates is beginning to free up the flow of funds and see short term rates move closer to the reference rates.
All of this turmoil has been going on in the financial markets but inevitably it has begun to affect the real economy. There were already significant signs of slowdown in the major economies and the financial crisis has only added fuel to this fire.
In the current climate - make your money work for you
Ireland is a case in point. The challenges faced in the property market and uncertainty over the banking system, have made for a very uncomfortable time for investors, be they individuals who have managed to accumulate some wealth during the Celtic Tiger years or companies who have built good reserves as a result of the same Tiger.
To safeguard for the future, people and companies need to make their wealth work for them. Since market indices first began, history has shown that real returns (return above inflation) are achieved primarily from investment in equities, followed by slightly lower returns from property and even lower again from government securities and bonds. In general cash returns have just kept pace with inflation and therefore have not given any real return over time – but is this really the case? At various periods of crisis or uncertainty in the last one hundred years, cash has been the only asset class that has shown any return in positive territory. The most obvious example is the great depression of the 1930s when the phrase “cash is king” was first coined.
As we face into these more challenging market conditions, it will become more and more difficult to turn economies around and return to a positive growth phase.
So what can investors do to protect their wealth and try to enhance it in times like this? Equity markets will anticipate the slow growth phase and returns will be low and it is likely that property will take some time to recover and show growth. What to do? I think the clue is in that well worn phrase - cash is definitely king at the moment.
Cash is king
Luckily the scarcity of funding for banks has meant that the depositor is the most sought after customer a bank can have right now. Every bank wants your money and is willing to pay for it. The deposit market is priced very much in favour of the customer and even well capitalised and well rated banks are paying the same prices as downgraded banks to attract funds.
This is the time for those with surplus cash to make it really work for them. As always, it is important to establish the degree of risk you are willing to take. For example, at the very low end of the risk spectrum you can place funds on a fixed term deposit where the only real decision is the duration. With interest rates unlikely to rise in the coming months there are very attractive offers for deposits which are placed in the six, nine and twelve month period. Leaving your funds in the shorter period will attract a lower rate of interest but is also likely to be negatively impacted if official interest rates are cut. Therefore, unless you believe you absolutely require access to the funds in the near term I recommend cash is placed on longer term deposit.
Alternatively, there are structured products available which can either provide 100 per cent capital guarantee or a part there of. Again it is important to establish your level of risk. As you would expect if you seek 100 per cent capital protection the potential gain is relatively limited as a significant portion of your investment is placed on cash deposit. Where you do not seek 100 per cent capital protection you have a greater potential return from the stock markets or property markets but equally you run the risk of losing some of your capital. Therefore the critical decision is “Can I afford to lose X percent of my capital?” One final important issue on choosing these types of products is they should be treated as long term investments ie. circa five years. Therefore funds should not be put into these products if you believe you may require access.
Remember these products have phrases such as “returns are not guaranteed” or “the value of your investment may go down as well as up” or possibly “past performance is not an indication of future results.” These statements are there for a reason – performance cannot be guaranteed and the market will fluctuate.
Hindsight proves that no one can accurately predict the future and in times of uncertainty not only is cash king but certainty is as well. |
Jimmy Doyle is director of group deposits at Bank of Scotland (Ireland).
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