Cash returns to the portfolio toolkit as liquidity gets repriced

For most investors, cash is the beginning and end point of the portfolio journey. It is where savings sit before they are allocated, and where investment returns eventually return before being spent.

That functional role is easy to overlook when markets are buoyant. Cash becomes the default, the drag, the lazy allocation waiting for conviction elsewhere. But the current environment has made that framing look too narrow.

As Tony Togher, Head of Fixed Income, Short Term Investments and Global Credit at First Sentier Investors, puts it:

“Cash is at varying times in market cycles, the best place to invest one’s money, however the way someone chooses to invest in cash markets, is equally important”

That matters for advisers because cash is not simply an asset class. It is also a behavioural tool, a funding tool and a risk management tool. It gives clients confidence that near-term spending needs can be met without forcing sales from risk assets at the wrong time.

The trade-off, of course, is inflation. Over long periods, cash has historically failed to preserve purchasing power. That is why investors exchange some of its certainty for the possibility of higher returns through duration, credit, equity, operating or liquidity risk.

The question for advisers is not whether clients should hold cash. They already do. The more useful question is whether that cash is being held deliberately, in the right structure, and for the right purpose.

The return of yield without duration risk

The most important change in the past two years is that cash is doing work again. After a long period in which defensive liquidity earned very little, higher policy rates have restored income to the short end of the curve.

First Sentier Investors’ recent analysis “Cash investing and the case for liquidity” argues that this shift has changed the role of cash in portfolio construction. Money market securities such as bank bills, negotiable certificates of deposit, commercial paper, treasury notes and floating-rate notes are now producing income that previously required investors to accept materially more credit or duration risk.

That has consequences for advice portfolios. Retirees drawing regular income, SMSF trustees managing contributions and pensions, and high-net-worth clients waiting for deployment opportunities can all now hold liquidity without feeling they are entirely sacrificing return.

Yet the form of cash exposure matters. First Sentier Investors compares its First Sentier Active Cash Fund with a strategy of rolling 12-month term deposits with major Australian banks over six years. The returns were broadly similar, with the cash fund slightly ahead overall, but the more important distinction was flexibility.

Term deposits can be useful in falling-rate environments because they lock in a rate at inception. They also offer simplicity. But they are blunt instruments. They typically provide liquidity only at maturity or with notice, often with an interest penalty.

An actively managed cash fund, by contrast, can adjust as rates change, diversify across counterparties and instruments, and offer daily liquidity. That makes it more than a rate product. It becomes a live portfolio allocation.

For advisers using managed accounts or model portfolios, this distinction is practical rather than theoretical. A liquid cash allocation can be rebalanced, trimmed, topped up or deployed as markets move. A term deposit book is less nimble and more administratively cumbersome.

Optionality has a price, and a value

The most interesting observation is tactical. Firms like Atchison Consultants have been running a higher-than-normal cash allocation because credit spreads have tightened and equity beta valuations have stretched. As markets have repriced, Atchison has been trimming that overweight.

That is a clean expression of cash as optionality. It is not necessarily a bearish view. It is a recognition that when compensation for risk looks thin, liquidity has value. When assets reprice, that liquidity can be redeployed.

This is where cash earns a place in the adviser toolkit. It can dampen volatility, fund client needs, provide income and preserve the ability to act. In uncertain markets, that last feature can be as important as the yield.

The mistake is to treat all cash as equal. At-call deposits, high-interest savings accounts, term deposits, active cash funds and short-duration income strategies all sit around the same conceptual space, but they do different jobs.

Some maximise simplicity, others the headline rate. Some prioritise liquidity, while others introduce modest mark-to-market movement in exchange for diversification and access to institutional money markets. Advisers need to be clear which feature they are buying.

The current environment makes that discipline more important. If inflation remains sticky, cash will not solve the long-term purchasing power problem. Growth assets are still required for that. But if equity valuations are full, credit spreads are tight and duration risk remains unpredictable, cash can help advisers avoid reaching for return at the wrong point in the cycle.

For retirees, it supports bucket strategies and reduces sequencing risk. Accumulators gain dry powder, while business owners, family groups and SMSFs can use it to separate operating liquidity from long-term capital. For advisers, it makes portfolio conversations more grounded.

Cash is still the most conservative part of the portfolio, but it no longer needs to be the least considered. In a higher-rate world, the quality of cash management matters. So does liquidity. So does the discipline to know when holding cash is prudent, and when it is time to spend that optionality.