Simon Tung is Head of Portfolio Management at Omega Global Investors. Omega is the Investment Manager of the Pinnacle aShares Dynamic Cash Fund (Managed Fund).
Imagine investing in a cash fund and not being able to access your capital when you want it, or even discovering that some of your cash has disappeared. Right now, this scenario might seem improbable, but history shows it’s not.
During the Global Financial Crisis an endless list of ‘cash funds’ which prioritised the hunt for yield at the expense of balancing risk and maintaining liquidity were frozen and ultimately closed, and in many cases, investors lost money.
Investors who should have been able to take out their capital and deploy it elsewhere as markets crashed were left paralysed.
The excessive risk in cash funds that was exposed during the GFC was well documented, but since then, very little has been written to warn investors (here in Australia and abroad) from being hit by the same issue in the event of another major credit event.
This is exactly what the Pinnacle aShares Dynamic Cash Fund (ASX:Z3RO) aims to avoid.
While achieving a competitive yield over the RBA cash rate, Z3RO’s priority is protecting capital and maintaining liquidity – this is something that sets our exchange traded cash fund apart from many others.
With cash rates at record lows after repeated rate cuts globally and by the RBA, it can be tempting to deploy your ‘rainy day’ cash into the cash fund promising the highest yield in their glossy brochure, but investors who want to prioritise capital preservation should be wary and look beyond that brochure and into the underlying investment process and portfolio.
Cash fund red flags
Unlike many other funds, little is discussed about the underlying securities used by cash fund managers to generate yield. Most investors, more than likely, simply assume they are low risk, stable and liquid financial instruments.
However, history has proven this isn’t neccessarily true. We suggest investors look out for these three red flags in order to avoid a repeat of the cash fund nightmare that occurred during the GFC.
1. Term deposits
Ask your cash manager, do they invest in term deposits? While these might help managers generate a few extra basis points in yield, they are also a major liquidity trap. In order for a fund to exit a term deposit before maturity they will be forced to pay an exit fee and like retail investors will be required to give a period of notice. This is in no way a liquid instrument.
2. Credit quality and duration
What would be worse than a major weighting to term deposits during a major liquidity event? Term deposits held with low-quality institutions. Ensuring managers use sophisticated analysis and deep experience to avoid issuer risk is vital, while funds that engage non-rated institutions should certainly be avoided.
Low-quality institutions (think Lehman Brothers) may offer slightly higher returns for investment managers but investors face the very real risking of losing it all if issuers fail.
Long-duration instruments in cash fund portfolios should also be considered as another red flag. While they may increase yield, the longer the credit duration, the more price volatility a portfolio takes and the higher the risk.
Generally speaking, high duration, high credit spread instruments carry a much higher risk of suffering material capital losses. If the yield looks too good to be true as a cash yield, it generally is.
A lack of transparency is probably the biggest and most identifiable cash fund red flag. Investors should be asking their cash managers what they’re holding in their portfolios. If this information isn’t easy to obtain, then you should be asking “is my manager hiding something?”. Too many cash funds in the Australian market today offer just a single line in their portfolio disclosure. Usually it says ‘cash securities’. But what are the securities? Are they generating yield through a bundle of risky, potentially volatile and illiquid instruments? If you can’t see the portfolio holdings, it’s hard to tell and you shouldn’t assume the best.
How does Z3RO activate your cash without risking capital?
As the investment manager of Z3RO, Omega Global Investors sticks to a disciplined investment process which has delivered consistent returns of 0.20%-0.50% above the RBA cash rate since 2011, as highlighted in the chart below.
Omega cash track record (from November 2011)
Source: Omega Global Investors.
To generate these returns for the Z3RO active-ETF, Omega manages a portfolio built around carefully selected investment grade money market issuers with maturity periods of 12 months or less. Term deposits are avoided completely. In short, Z3RO matches the liquidity needs of investors with the true liquidity of the underlying assets in the active-ETF.
Most of the assets in the fund are money market securities, with zero exit fees. These are securities which are traded in massive volumes by the major Australian banks on a daily basis – enabling high liquidity.
Z3RO’s investments are also screened using propriety Omega Financial Health Rating (OFHR) modelling to avoid poor quality issuers which pose a risk to our investors’ capital.
The OFHR quantitative system rates the probability of a negative credit event. Issuers with low OFHR scores are avoided. The following chart highlights how the system eliminates a tier 1 Japanese bank with assets US$1.8trln (2017), even if their current S&P rating is strong.
Substantial difference in Bank Credit Risk
Source: Omega Global Investors.
We believe our OFHR modelling allows us to be ahead of the game and predict where defaults may occur and the probability of future ratings downgrades. This modelling may have prevented investments into those fateful instruments issued by Lehman Brothers.
Our disciplined and astute process ensures our investors’ cash is working hard at times of the market cycle when they want or need to hold cash. Just as importantly, it also ensures that cash can be easily and quickly redeployed when required, regardless of global economic events.
If you value your capital, risk and liquidity should not be overlooked when selecting an investment to activate your cash.
Not only does Z3RO achieve the desired trade-off between generating competitive yield and maintaining low levels of risk, it comes with ZERO management and performance fees.