Captives’ over-reliance on cash can be self-defeating so they should look towards other asset classes for healthier returns, according to London & Capital.
In the first edition of London & Capital’s Captive Indices, the firm said that while gravitating towards very large cash holdings is the safe bet, low interest rates mean that captives can easily find themselves watching their cash wealth being eroded by inflation, as their discounted liabilities grow.
High-grade corporate bonds, high-yield bonds and US equities all significantly outperformed cash over the past decade, found London & Capital, making them an attractive alternative.
“In a low interest rate (and possibly inflationary) environment, the case for relying solely on cash will likely be damaging to returns. Nor is a large investment grade bond allocation likely to truly maximise returns.”
“These may have been more stable during crisis periods—such as the eurozone debt crisis of May/June 2010—yet in the longer term their returns were lacklustre compared to assets with higher intrinsic volatility.”
Looking forwards, London & Capital believes that markets are in the latter stages of recovery, with consumer and business confidence rising off the back of improved economic activity and investors anticipating a reduction in monetary accommodation by policymakers.
The firm predicts that improving profitability and large cash reserves will continue to support high-grade corporate debt, although volatility in government bond markets may result in some sporadic periods of volatility in investment grade corporate bonds.
Reduced credit risk, falling defaults and attractive yields will also boost high-yield bonds, while equities will also enjoy the tailwind of improving company earnings and greater pricing power, according to London & Capital.
