Cash and gold protect investors against falling equity prices
Physical commodities are used to spread portfolio risk as some move in different directions to the market
Market prices pulled back in March 2020 to 2008 global financial crisis levels because of the Covid-19 pandemic. The equity sell-off left investors searching for safe havens during extreme bouts of market volatility.
Two asset classes play significant roles when a market event occurs: cash instruments and certain commodities tend to provide investors with a potential shield to falling equity prices.
Gold tends to play a role in all market events as an asset that is turned to during a sell-off. March 2020 was no different, with many investors turning to the physical commodity to provide much-needed relief. Physical commodities are used by investors to spread portfolio risk, because certain commodities move in different directions to the market. The most popular of those commodities is gold.
Gold was negatively correlated in 2008 to market performance; when markets fell the gold price rose. That is because investors pulled their funds from equities and invested in gold, increasing the demand for the commodity and increasing the price. The same pattern emerged in March 2020, when global equity markets had another mass sell-off. Investors with exposure to gold in 2008 and 2020 were effectively hedged in, reducing some of the downside equity risk when the market sell-off occurred.
Cash is another asset class that can be used as an effective tool to hedge equity risk. Investing in the stock market and sitting on cash might seem like mutually exclusive options, but cash instruments play a key role in the successful diversification of portfolios. In times of economic downturn and market pullbacks this defensive asset can play a hedging role in protecting wealth from equity downside. Having cash in a portfolio means being able to take advantage of opportunities when they present themselves in the market. Warren Buffett said: “Cash is to business as oxygen is to an individual: never thought about when present, the only thing in mind when absent”.
In times of market volatility and increased risk cash instruments should be considered by investors as a diversification and risk-mitigation tool. Adding a cash element to a portfolio allows an investor to decrease portfolio risk and secure an additional income stream in the form of interest. Long-term investors see cash instruments as a defensive asset that produces consistent, reliable returns in a risk-averse manner. However, this asset class can also be used by investors to go on the offensive. Investors with large amounts of cash in their portfolio can easily take advantage of investment opportunities and potentially buy assets of value at discounted prices when markets pull back.
Cash as an asset class is extremely liquid and can be used to buy assets when needed. Just having exposure to equities will mean having to sell those shares to acquire another investment. This can mean selling shares at the incorrect time when market prices do not reflect value. Having cash exposure can result in an investor having a war chest for when the right opportunity presents itself in the market, as well as receiving stable, consistent returns on the cash instrument utilised.
Many different cash instruments can be used in achieving investment goals. A cash investment is far more than just a traditional savings account. Money market accounts and funds can be used to achieve higher cash returns than a traditional savings account. Investors receive higher returns due to the minimum deposit required as well as maintaining certain balance amounts. Money market funds like mutual funds give investors access to different cash securities, however these securities are all liquid and maturing within 13 months.
These types of assets allow investors to gain exposure to the repo rate as well as the Alexander Forbes short-term fixed interest (SteFi) composite index. Investors can also look at investing in instruments for a certain period through a notice or fixed deposit. The difference between these instruments is that a notice account has a variable rate of return, while a fixed deposit allows an investor to secure the interest rate for the duration of the investment. Both assist investors in diversifying risk through reliable and consistent interest streams.
One thing that has come to light due to the global pandemic is the role diversification plays in sheltering investors from total losses. In a bull market diversification can be overlooked by investors as prices are increasing. However, in a market event any weakness in a diversification strategy is magnified. Diversification means investing in assets that do not move in the same direction through economic cycles.
Gold and cash instruments are useful tools that should be considered by investors looking to spread portfolio risk, building a portfolio that will stand strong against future market events.
• Riemer is investment education head at FNB Wealth & Investments.
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