Credit: The Case for Bonds Over Deposits
Shift cash towards high quality credit with the Liquid+ Strategy
Chief Investment Office, Daryl Ho17 Mar 2023
  • Recent bank failures highlight the risks of traditionally “safe” cash deposits
  • Should a Fed pause be on the cards, it usually does not bode well for high cash yields in future
  • Credit usually outperforms cash at the end of the policy hiking cycle
  • Capitalise on this narrowing window of high rates by shifting cash towards high quality credit
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Whose deposits are they anyway? In light of recent bank failures and stresses, the previously undisputed notion that cash deposits are always and everywhere “safe” has been called into question. Under normal circumstances, those with money in the bank do not often consider that, outside the insured limits in their various jurisdictions (e.g., the Federal Deposit Insurance Corporation insures up to USD250k per depositor in the US), one turns from a depositor to a senior unsecured creditor of the bank. Clearly, being a senior unsecured creditor is of material concern when the solvency of the debtor is in doubt – as was the case with the recent failures of Silicon Valley bank and Signature bank in the US. 

Bad news comes in pairs – high returns of cash is now at risk. Not only have concentration risks of cash deposits been made apparent, but so have return risks. Banking sector-related stresses have resurfaced narratives of monetary policy tightening having run its course, resulting in a massive 1.5% decline in the December Fed funds futures pricing since end-Feb 2023. Should this signal a pause in/the end of the Fed hike cycle, the days of high yields on cash deposits are certainly numbered, if history is any guide.

Cash or credit? This was the premise for our long-standing preference for quality credit over cash deposits, given that investors (a) can be well-diversified rather than have financial sector concentration risks, and (b) can lock in higher yields for a longer duration than the fleeting high rates of cash. The past 20 years illustrates this clearly; cash yields hardly ever come close to IG credit for more than a year. This means that investors are often better off taking a bit of duration risk in IG credit to lock in such high yields for a longer timeframe.

Moreover, high cash rates are not sustainable in a highly leveraged world; when cash and IG yields coincide, a recession generally ensues which forces rates lower again. Investors who hold only cash would merely see reinvestment risks with the decline in rates, while IG credit investors would experience capital gains as the rate environment adjusts lower, lifting bond prices.


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