Cost of safe haven investing: cash and gilts lose money in real terms

It’s been better to be a hare than a tortoise when it comes to investment markets over the last decade. Cautious investors have significantly underperformed the global stock market and in some cases, they’ve seen the value of their money actually go backwards once inflation is taken into account. More conservative investors will be used to the idea that they won’t make as much money in bull markets, but the sheer scale of the returns they have missed out on from investing in the stock market is pretty galling.

Bond investors in particular may well be disappointed they have had to endure such high levels of volatility to achieve meagre long-term returns, which have fallen behind inflation. In part this can be attributed to the huge directional change in monetary policy which routed the bond market in 2022. While there are no guarantees, gilt holders are likely to have a smoother ride going forward now the bond bubble has popped, and 60/40 fund investors can probably likewise expect greater stability from the fixed interest side of their portfolio.

Cash has been a wealth destroyer over the last decade, with the average Cash ISA turning £10,000 invested into £8,456 after accounting for inflation. Clearly interest rates are now substantially higher than they have been for the last ten years, though the longer-term risk of inflation still threatens cash savings, especially seeing as several interest rate cuts are pencilled in for this year. Even over the last year, the average Cash ISA has returned 2.7% compared to 17% from a global index tracker.

Clearly an investment in the global stock market has ups and downs, and won’t be returning 17% year in, year out. But historical performance also tells us that cash is very unlikely to match the returns provided by equities over lengthier periods. Data from the Barclays Equity Gilt study going back to 1899 shows that over a ten year time period, UK shares have beaten cash over 90% of the time. Moreover cash produced negative real returns in six of the eleven decades between 1912 and 2022.

Safe haven performance

Sources: AJ Bell, Bank of England, FE, Morningstar, ONS. Total Return in GBP to 31 December 2023, Gold: performance of average of three gold ETFs, 60:40 fund: Vanguard LifeStrategy 60% Equity, Gilt fund: IA UK gilts sector average, Absolute Return fund: IA Targeted Absolute Return sector average, Cash ISA: effective interest rates on Cash ISAs. Global Passive Equity fund: Fidelity Index World

Gold – always believe in your goal

Gold has been a bright spot amongst the safe havens. An investment in a gold ETF would have more than doubled your money over ten years. Conditions over most of the last decade have been ideal for gold to shine; low interest rates, currency debasement, and a series of large economic shocks. However this return has not been achieved without some thrills and spills along the way. Over the last ten years the volatility of gold has been in line with that of the global stock market, and in 2013, investors saw their holdings plummet by almost a third.

This is not particularly unusual behaviour for the precious metal. Gold is often seen as a safe haven, but investors also need to be careful not to equate this with price stability. People do tend to turn to the precious metal in terms of financial stress, but it shouldn’t be taken as read that gold isn’t volatile. It is, and steep losses can be incurred. Between 1980 and 1982, the gold price fell by over 50%, and between 2011 and 2015, it fell by over 40%, in sterling terms. From its peak in 1980, the gold price fell by 57% in sterling terms over the next 20 years, and it took until 2006 years for gold to reach its former high. That’s a long period in the wilderness.

Gold bugs might advance the argument that the stock market is not much better. It took the FTSE 100 until 2015 to regain its 1999 high. But there is one important dividing line between the returns accruing to shares versus gold – dividends. While the FTSE 100 may not have made any price progress between 1999 and 2015, investors would have received dividends along the way, which if reinvested would have produced a total return over the period of 67%. Gold pays no income and so doesn’t enjoy this luxury.

The volatility of gold means that investors whose goal is to reduce risk shouldn’t seek a naked position in the precious metal, that is to say one which is not covered up by other assets. In combination with shares and bonds, gold can fulfil a useful role in a portfolio because it tends to wax and wane at different times to other assets, and so can lead to a smoother journey at a portfolio level. But trading gold as a standalone investment is a risky game, a bit like Bitcoin without the steroids. Investors should seek to hold a maximum of 5% to 10% in gold in a diversified portfolio.

60/40 Portfolio – a respectable performance in difficult conditions

A 60/40 has fared reasonably well for cautious investors over the last decade, delivering returns significantly ahead of inflation while also experiencing a limited downside. A 60/40 portfolio invests 60% in equities and the remainder in fixed interest. If there was a criticism it might be that returns have trailed so far behind the global stock market, turning £10,000 into £18,707, compared to £30,172 from a global passive equity fund. However, cautious investors should know this is the quid pro quo, they give up higher returns for more stability along the way.

On a calendar year basis the 60/40 portfolio has actually fallen by more than the global passive fund, registering an 11.2% fall in 2022 compared to an 8% fall by a global passive fund. This was a result of falling equity markets coinciding by a once in a generation rout in the bond market, stemming from a dramatic U-turn in monetary policy. However over the course of the last ten years the 60/40 portfolio has exhibited just over half the volatility of a global equity index tracker, and notably during the pandemic sell-off of the first few months of 2020, the 60/40 portfolio fell by 18%, compared to a fall of 26% from a global passive fund. So investors have enjoyed some downside protection from the 60/40 approach.

A multi-asset portfolio like a 60/40 fund is a good compromise for cautious investors who want some exposure to the stock market, with some downside protection to help them get to sleep at night. These sorts of funds have become very popular in recent years, with both advisers and DIY investors, and come in different shades of risk to suit a wide range of investor appetites.

Cash – a revival in fortunes

The typical Cash ISA has delivered a negative real return over the last decade, and those who chose cash over shares have missed out on some exceptional performance from the stock market. Now interest rates have risen, cash is of course looking more attractive. The problem is returns over the next decade will be dictated by what the Bank of England does with interest rates, and how much commercial banks decide to pass on to investors. One would certainly hope the next ten years are better for cash savers than the last. But if you’re putting away money for that long, then you should really be considering investing in the stock market, given the likelihood it will deliver superior returns. Cash is of course extremely useful for rainy day funds you might need to draw on at any time, because of the fact that it doesn’t fall in value in nominal terms. A cash buffer of three to six months’ expenditure is normally prudent. Holding larger sums of cash for longer periods risks losing out to inflation and missing out on the wealth generated by stock market investing.

UK gilts

Gilts also experienced a big drawdown, in 2022, which saw the average gilt fund falling in value by almost a quarter. Not exactly putting the ‘safe’ into ‘safe haven’, but that fall was really a once in a generation event heralded by a dramatic U-turn in monetary policy from an exceptionally low base level. Probably more disappointing are the returns harvested by bond investors over this period, with almost all of the performance of the bond bull market given up, and the typical gilt fund registering negative returns over ten years once inflation has been taken into account. The good news for gilt investors is that prices have reset to much more reasonable levels and yields look relatively attractive. There are still risks out there, notably sticky inflation, the UK election, and the potential for a supply glut coming from a combination of Quantitative Tightening and new issuance. However the risks and returns on offer look far more balanced than they have since the financial crisis.

Absolute return funds

Absolute return funds were supposed to be the answer to the big investment losses racked up during the financial crisis. To be fair, these funds have largely succeeded in that mission, with the sector average falling by at most just 2.8% in any calendar year in the last decade. However on the other side of the ledger, returns have been poor, and absolute return funds have on average delivered a negative real return over the last decade. Not all funds have been duds, with ten year returns ranging from -3.6% up to 87.9%.

This sector includes a wide variety of different approaches but there are some structural issues which may have led to lacklustre performance. One is the prevalence of performance fees in the sector, a hangover from the hedge fund roots of absolute returns funds. As within the hedge fund industry these performance fees are often levied alongside, rather than instead of, chunky annual management fees. Some of these funds also try to take a market neutral approach to investing by shorting stocks and indices. That serves to reduce correlation with the market at large, but it also curtails one of the most powerful forces investors can harness: the long-term upward grind of the stock market. Instead it throws the emphasis onto the fund manager to replace that with judicious stock picking, both on the long and short side of their book. Limp returns over the last decade suggest that hasn’t been a wholly successful endeavour.