What to do with your cash?

If there's one asset we're all familiar with, it's cash. It's part of everyone's portfolio, investor or not, sometimes intermittently, sometimes permanently. In principle, it's the only asset everyone owns, because they don't want to, can't or don't know how to invest in other assets. Cash seems to them, wrongly, to be the only thing that guarantees the survival of their capital. However, any prudent investor knows that cash is, on the contrary, the asset of choice for losing money over the long term.

I can still see my grandmother sneaking up to the attic to get her hidden banknotes. Regardless of the risk of theft, it was certain that she would find exactly what she had deposited there. In her mind, every franc hidden there was something very concrete. A franc would always be worth a franc, no matter what. She was 100% right, except that she forgot that while the value of her money didn't change, the value of bread, fruit & vegetables, rent and insurance did. The figures on her bills were always the same, but she needed more and more bills to live on. She wasn't the type to go to the casino... You can make fun of my grandmother, but she's not that different from all the other people who invest their money exclusively. on a bank account, even for savings.

That said, cash is not all bad news. First and foremost, it's useful for building up a capital base. emergency fund. Before you start investing your money, you need to make sure you're protected from any unexpected financial event that might force you to close out some of your positions, perhaps at a loss. It's also important to always have small reserves of cash on hand, so as to be ready to seize opportunities on the stock market should they arise. Cash is also often used as one of the strategic assets in a portfolio, for example in the Permanent Portfolio. It can also be part of an intermittent investment strategy based on fundamental or technical criteria. This is the case, for example, with the Ivy Portfolio of Meb Faber. We can also have cash simply because we can't momentarily find an interesting asset to invest in. This is particularly true when bonds and equities are simultaneously unaffordable. It's easy to find yourself borrowing, because these periods can go hand in hand with very low interest rates, as is the case at the moment. This means that you'll have to let your cash sit idle, waiting for something better to come along, and that it won't earn any interest at best. On some accounts, you may even be charged administrative fees, or worse, negative interest rates (typically if you have CHF in foreign accounts).

It's almost impossible, and even counterproductive, not to own cash. On the other hand, the higher the proportion of cash, the more likely it is that investment income will fall, especially when interest rates are low.

An alternative is to invest in very short-term bonds. Maturities need to be very short, because you need to be sure of being able to withdraw your money at any time, without losing money. The shorter the maturities, the lower the risk, but also the lower the yield. Given the current low interest rates in Switzerland, this is clearly a problem, since you can even lose money on short-term loans. The situation is not much better with our European friends.

Rates are much more attractive in the USA, where the Fed's monetary policy is becoming increasingly less accommodating. The dollar currently offers an interest rate of 2.4%, which makes a welcome change from the negative rates on the CHF. However, investing in the dollar also means taking on currency risk, which is not really the point. Admittedly, investing in the dollar over the medium term may be worthwhile, given the central bank's tightening of the screws, but let's not forget that the greenback is a structurally weak currency in the long term, and that it can also fluctuate significantly in the short term. A cash position should not vary unexpectedly from one day to the next, otherwise it would no longer fulfil its role as an immediately available asset.

Let's take the example of the ICSH ETF, listed in NY in USD, which invests in short-term bonds and money market instruments. ICSH currently offers an attractive yield of 2.66%, and is particularly stable for short-term investments, as can be seen in the chart below. A priori, this investment meets the requirements of an asset that can be sold virtually overnight without fear of having to sell at a loss. Over the last five years, it has returned 6% (including coupons), or 1.1% per year. It's not much, but it's something, especially as rates were quite low in the early years.

However, if we look below at the same stock valued in CHF over the same period, the picture is markedly different. We're certainly not far off the volatility of equities, but we quickly realize that currency effects lead to significant variations in asset value, even over short periods. Leaving aside the January 15, 2015 "crash" caused by the Swiss National Bank's abandonment of the floor rate, the fact remains that ICSH's share price is never stable in CHF, unlike it was in USD. It is therefore impossible to invest cash in this ETF if you wish to use it as an immediately available asset. Paradoxically, however, it has performed better in Swiss francs, with a return of 19.5% over the last five years (including coupons), or 3.5% per annum. The greenback's strong performance against our national currency over this period explains this phenomenon. The danger, which goes far beyond the simple volatility induced by this method, is that in the long term the dollar tends to move in the opposite direction to the Swiss franc.

A bad idea would be to invest in this ETF while hedging against currency risk. This can be done, for example, by borrowing dollars, with a CHF/USD futures contract or an option on the same contract. The problem is that the difference between the return offered by the ETF and the interest rate on the dollar is so small that you're guaranteed to lose money with this solution.

So, are we condemned to live for a long time with CHF that yields nothing at best? Yes and no. First of all, it should be noted that the Swiss franc, although it pays no interest (or even charges interest), is a strong currency. It therefore tends to appreciate against other currencies over the long term. This means you're getting richer and richer with your francs than with other currencies. The long-term depreciation of the dollar against our currency is a case in point, as shown in the graph below (although this doesn't mean you should give up on US equities, as they're the best way to protect your money). most of them love it when their domestic currency depreciates(particularly those of companies with strong international exposure and those active in commodities).

From a certain point of view, CHF is the monetary equivalent of gold in commodities. It doesn't (currently) pay out and, like the yellow metal, it's a safe-haven asset. Their respective prices against the dollar therefore tend to behave similarly over long periods. Over the long term, both rise against the greenback. The Swiss franc is, in a way, our very own gold.

It is therefore in our interest to remain invested in the Swiss franc, at least if we have no other alternative to invest in higher-yielding assets (equities, real estate or bonds, for example). Nevertheless, even if they appreciate in value relative to other currencies, it can be frustrating to own CHF cash, especially if it's plentiful.

For this reason, I drew inspiration from my work three years ago on the Trading Auto Signalwhich I had to abandon due to changes in my service provider at the time. I turned to the USD/CHF pair, with the idea of benefiting both from the franc's long-term strength, while making a few extra profits on shorter-term variations in this currency pair, when market conditions allow. The approach is simply to be cash in CHF when rates are sufficiently remunerative. If this is not the case, we convert them into greenbacks when the latter have depreciated considerably over a short period of time, before reverting to the Swiss franc. For 3/4 of the time, we invest in Swiss currencies. What's more, in the event of particularly low rates on both currencies, the signal is likely to exceptionally take a position on the SPY index ETF.

The algorithm thus tested gives a backtest average annual performance (net of fees) of 3.41% in CHF over 20 years. That's not much, but it's considerably better than the average 0.79% per year we'd have obtained over the same period by letting our Swiss francs sleep on a bank account.

The graph below shows the evolution of CHF 20,000 invested on December 31, 1998. It shows that, over very long periods, the signal remains invested in CHF and only grows in line with interest rates. So there's absolutely nothing to be done for all that time. Then, when Swiss rates become discriminatory, the signal begins to oscillate between CHF and USD in the short term. It's worth noting that between autumn 2013 and spring 2015, the signal was even invested in the SPY ETF due to an exceptionally weak interest rate situation for both currencies.

 

 

Attentive investors will have noticed, however, that there is a small price to pay for this method. You can sometimes lose a few percentage points (the worst loss in twenty years was 7.9%). It's rare, it never lasts very long, but it obviously means that cash loses its role as an immediately available asset. For this reason, I recommend splitting the cash portion into two parts, one half devoted to imminent needs, still invested in CHF, and the other half devoted to medium-term needs, invested in the monetary signal presented above. Of course, this results in a slight loss of profitability, since the average annual return is 2.26%, but it is still 1.47 percentage points higher than the interest rates paid on CHF. With this approach, we can be sure of always having cash available immediately.

By using the above-mentioned ICSH ETF during the dollar phases, you can still make a few extra gains, provided, of course, that you don't have to pay excessive commissions. This is the case with Interactive Brokers, for example. However, the additional gain is so minimal (0.02% per annum on average), once all fees have been deducted, that it's not worth it.

In short, this method allows you to earn a little more with your cash, without working miracles either. It makes all the difference when Swiss rates are miserable, as is currently the case. For those with a foreign account, such as Interactive Brokers, it's a great way to make money with cash, despite the negative rates charged on CHF.

From now on, I will include my asset allocationthe instrument determined by the signal to invest in medium-term reserves.