Cash under pressure

The challenge as an investor of finding reasonable investment returns in the current environment cannot be understated.

There is no asset class under greater pressure than cash – an RBA cash rate of 1 per cent with inflation of 1.6 per cent means that cash investments earning a rate equal to the RBA cash rate is actually going backwards. Before Tax. (Although those prone to whistling ‘always look on the bright side of life’ as they walk along might point out that there really isn’t much tax to pay given how low interest rates currently are).

There is pressure to look for higher returns from the cash part of investment portfolios.

There is a recent warning relating to this type of behaviour – the collapse of mortgage funds such as Estate Mortgage and Westpoint happened at a time that many investors were looking at them as the simple solution to their portfolio challenges. They seemed to offer fixed ongoing payments to investors that were attractive, with no obvious risk. Until they collapsed. 

The challenge remains for investors, despite the low returns from cash investors, to be thoughtful about the level of risk that they expose this part of their portfolio to. There is a common investment saying, ‘shares let you eat, cash lets you sleep’. There is no need to be lying awake at night because you have taken on extra risk with your cash, in the hope of extra returns.

I have recently come across some advertisements for financial products offering the sort of cash alternative that I think is dangerous. Trilogy Funds is one of those managers, offering an enhanced cash fund, offering in very large font a 4.72 per cent July distribution rate, and in very small font (that actually could not be completely read because of the positioning of the background photo) the promise that past performance is not a reliable indicator of future performance.

Be that as it may, if a ‘large fonted’ return of 4.72 per cent is on offer in an enhanced cash fund, it is worthy of further investigation to see whether this fund has a place in the cash assets of a portfolio.

Let’s start with the issue of capital stability. For all the talk about low interest rates, the current Government guarantee of cash deposits for individuals of $250,000 for Authorised Deposit-taking Institutions (ADI’s) provides a tremendous amount of certainty that the capital is safe. Reading the product disclosure statement (PDS) of Trilogy does not provide the same amount of certainty. Firstly, there is no capital guarantee. The unit price of the trust is fixed at $1.00 per unit however the PDS states that in the event of a loss of value of the assets of the fund, there will be a capital loss for investors.

It also discloses that the constitution allows, and in certain circumstances requires, the compulsory redemption and cancellation of some units – meaning investors end up with less units, no payment, so that the unit price stays at $1.00. This does not sound particularly cash like to me.

Being a managed fund, it is important to think about the underlying assets of the fund – are they of cash like quality? This is particularly important given the mechanism to cancel units for ‘no value’ as outlined in the PDS.

The fund is invested 70 per cent in ‘cash and cash style’ investments, and 30 per cent in the Trilogy Monthly Income trust. Some of the investments in the 70 per cent of the portfolio look well suited to a cash investment, for example, term deposits and bonds, however some of the others such as ‘promissory notes’ raise concern about whether non-traditional (outside of the scope of cash accounts, term deposits, investment grade bonds), unrated fixed interest securities such as promissory notes have a place in the cash part of an investment – my feeling is not. It is interesting to look at the 30 per cent of the portfolio invested in the Trilogy Monthly Income trust. 

This fund boasts a 7.5 per cent July net distribution rate, and is described as a pooled mortgage investment. The simple reality is this – I am paying about 3 per cent for my mortgage. Borrowers paying the Trilogy Monthly Income trust enough interest that the fund is paying a 7.5 per cent distribution plus fees must have a degree of risk with them, and again I would say that these assets don’t have a place in a cash investment.

The fees raise an interesting issue. The fees in the enhanced cash fund are not eye watering – management costs of 0.87 per cent. However, the fees in the 30 per cent of the portfolio invested in the Trilogy Monthly Income fund worthy of comment, being a 0.96 per cent management fee and an average borrowers fee of 2.65 per cent of funds under management. This amounts to total fees of more than 3.61 per cent, which stands in the way of investors getting a fair risk adjusted return.

The last issue is liquidity. 

One of the important roles of cash in a portfolio is that it is immediately available – even with a term deposit you can generally access it part way though a term if you are prepared to forgo the interest accrued.

The enhanced cash fund does not offer the same ease of access, with the PDS stating that the fund ‘aims to pay’ withdrawals within seven days, and is allowed by the constitution to pay within a ‘reasonable period’ not exceeding 6 months. The PDS sets out the possibility of a freeze on or suspension of withdrawals. 

The decision for me is simple – the possible lack of liquidity, the lower credit quality of assets, the high fees and the lack of capital stability means that I don’t see the Trilogy Enhanced Cash Fund as being an investment to consider in the cash assets of a portfolio. 

While there is an argument that a company like Trilogy may have had a track record of making attractive interest payments over a period of time, a connected series of negative events (for example an economic downturn that sees the default rate on mortgages increase, an decrease in the interest received by the fund, an increase in redemption requests that the fund can’t meet, a freeze on assets) can challenge that record.