Cash and the fourth dimension

Until recently the consensus view in the retail press and amongst many of the investing public was that cash, and only cash, constituted low risk investment.  However, following the failure of the Icelandic banks and fears about the solvency of banks generally, both here and virtually everywhere else worldwide, such an assumption suddenly seems rather shaky.

 We recently launched a cautious equity-based fund which was held largely in cash until mid-October.  Against a background of tumbling equity markets imagine our surprise that all enquiries by prospective investors and their advisers about the security of the fund focused purely on the cash holdings!  Investors seem well acquainted with the perceived risks within the equity markets (the memory of 2000-2003 is fresh in their minds) but suddenly are worried about the security of their cash holdings.  This brings me on to consider risk in the wider context where I see two distinctly different categories of risk – absolute risk and price risk. 

 Absolute risk is related to losing one’s stake in its entirety – as one generally does on the gaming tables.  In investment terms this normally only happens when the entity in which you have invested, primarily as a shareholder or sometimes as a depositor (think Icelandic banks), goes bust.  It can also happen when a company is nationalised, such as Northern Rock, when shareholders also lose everything. 

 Price risk, on the other hand, is where an investor buys an asset for which the price is determined by the market forces of supply and demand.  If you buy RBS shares today, will the price rise or fall between the point of investment and any subsequent sale?  Having fallen some 90% or so from its peak and now that its future has been underwritten, RBS should have zero absolute risk and, probably, a very low price risk (the FT website was recently quoting a prospective running dividend yield of 33% – we know this wont happen but it puts the current share price into context compared with recent profit and dividend levels).

 There is little to say about absolute risk other than to emphasise that it is sensible for investors to do adequate due diligence before investing in any company that is vulnerable to currently deteriorating economic conditions.  There is plenty to say about price risk and it is here that the fourth dimension of time, and of course timing, comes into play.

 Both Warren Buffett and Bill Mott have gone on record recently to say that all the risk is currently in cash.  This is not because of prospective bank insolvencies but because interest rates are going to fall to very low levels so that real returns from holding cash are likely to be negative, even if one allows interest to roll-up.  On the other hand equity investment at this historical point in the market is likely to offer both decent yields and substantial capital growth, so long as one follows the basic rules of investment – of which number one is diversification and number two is to invest for the medium to long term (the fourth dimension).

I believe that equity value in the markets is greater than at any previous point in my lifetime and likely to be greater than at any point in the rest of my lifetime.  Of course prices could go lower (although I doubt they will go much lower) but in years to come this period will be looked back on as a once in a lifetime opportunity to make big money from equities – especially in the sectors which have bombed so badly in recent days and weeks.  Personally I am borrowing what I can to buy banks, builders and miners right now, many of which are down 90% or more from their recent peaks.  Even a recovery to only 25% of previous levels equates to a performance of several hundred percent from this point!

Paul Wilcox,
Chairman & Technical Director, WAY Group.

Posted on 28th October, 2008 |
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