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Diversifying your cash: Exploring investment solutions in an inflationary environment

25th March, 2024

In 2023, annual inflation in Ireland averaged 5.2%, putting significant pressure on individuals earning low rates of interest on cash deposits. We also saw the European Central Bank (ECB) hike interest rates to above 3% for much of the year and to 4% by September. To help our clients overcome this inflationary environment, at Davy we introduced a range of investment solutions as alternative ways for investors to park their excess cash. These solutions are diversified, liquid and safe options for short-term cash needs. They currently offer attractive yields, appealing to those that value both liquidity and the potential for returns on their money.

Depending on your investment horizon and liquidity needs, we have different solutions structured for you, ranging from very short-term liquidity funds like Money Market Funds, with the maturity of underlying investments currently at just under three months. We also look to slightly longer-term Government Bonds (maturity of up to two years) and then a Low Duration Credit Fund (maturity up to five years). In this article, we will explore each of these options.

Money Market Funds

Last year, 2023, marked a significant rise in the popularity of liquidity funds, attracting over $970 billion in assets globally. Money Market Funds are funds that invest in short-term, high-quality debt instruments such as certificates of deposits, commercial paper, Treasury bills, and repurchase agreements (repos). They offer investors high liquidity, meaning you can easily buy and sell units in the fund without much worry about price fluctuations. Furthermore, these funds allow investors the potential to earn good returns from these diversified, higher-yielding instruments (compared to returns on cash deposits).

The increase in interest rates by central banks globally, such as the Federal Reserve and ECB, has made the yields on liquidity funds relatively attractive. Coupled with their flexible nature, these funds now stand as a competitive choice compared to traditional cash deposits. Especially in Ireland, where the adjustment of deposit rates by local institutions has been slow, liquidity funds offer notably attractive yields and returns.

Short Term Government Bonds

With maturities ranging from a few months to two years, our range of short-term global government bonds has appealed to many investors over the past year. The rise in interest rates has made yields on government bonds increasingly attractive, especially for short maturity bonds. The benefits of investing in government bonds include attractive yields, safety, and high liquidity. From a tax perspective, these investments typically incur Capital Gains Tax (CGT) on gain (33%) and income tax on the coupon, making them potentially more attractive compared to money market funds subject to fund exit tax (41%).

However, investors do face reinvestment risk as there is no guarantee they can reinvest at the same attractive yield when these bonds mature in a year or so.  Of course, this risk also applies to other liquidity investments.

Low Duration Credit Fund

This fund has a short duration of 2-3 years and is ideal for clients willing and able to commit their capital for a period of three years or more. Predominantly composed of investment-grade funds, the fund maintains a prudent risk profile with only a 10% allocation to high-yield bond funds, strategically enhancing overall yields.

Currently, the fund offers an attractive yield to maturity of 4.3%, presenting an appealing opportunity for new investors seeking competitive yields. With a duration of 2-3 years, the fund is more sensitive to interest rate movements, both up and down, compared to short-term bonds and Money Market Funds. Given that yields and prices move in opposite directions, if we have reached a peak in rates, then a fund with a longer duration should perform better when the path of future rates is downwards.

In conclusion, we offer various solutions for investors seeking to preserve and grow their cash compared to traditional savings accounts. Money Market Funds, short-term government bonds, and low duration credit funds offer varying degrees of liquidity, safety, and attractive yields, catering to different investment horizons and risk appetites. Diversifying across these investment vehicles could prove beneficial in navigating the current economic landscape, providing avenues for both growth and stability for investors.

See the full potential

In inflationary times, doing nothing could be your riskiest move.

Get in touch

See the full potential

In inflationary times, doing nothing could be your riskiest move.

Get in touch

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