Investors should look to bonds and emerging-market stocks instead of holding cash as inflation climbs, UBS says

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Investors should look to bonds and emerging-market stocks instead of holding cash as inflation climbs, UBS says
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  • Inflation risks and central banks signaling rates are on hold will eat into cash returns, says UBS.
  • The firm says investors should consider sovereign debt outside of the US in their search for yield.
  • There's an "excess" in cash being held by private investors, UBS argues.

Investors with an "excess" amount of cash should consider reducing those holdings in the face of rising inflation and seek yield in select bond and equity markets, according to UBS.

Wall Street has taken note of the steepening yield curve, which reflects expectations among investors of further improvement in the US economy and an increase in inflation. Those expectations have been on the rise in part as the Biden administration is looking to unleash $1.9 trillion in stimulus funds aimed to help Americans still coping with the COVID-19 pandemic.

The 30-year Treasury yield on Monday pushed above 2% for the first time in nearly a year as part of a selloff in US bonds.

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But "central banks have made it clear that policy rates are on hold," even as optimism over global growth has brightened, said UBS in a note published February 5. "That means real rates will stay negative, and any lasting increase in inflation will drive them down further."

The firm continued: "In a world of negative real returns on bank deposits, we recommend investors consider putting excess cash to work."

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In assessing liquidity needs via a three-tiered approach, the third tier would be for cash to cover potential investment opportunities over the coming two to five years, UBS said.

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Investors "who can consider taking on more credit or counterparty risk have the potential to earn higher returns in Tier 3, for instance by investing in short-term corporate bonds," the firm said.

Also, investors searching for yield should consider US dollar-denominated emerging market sovereign debt as its 4.7% yield is roughly 360 basis points above US Treasurys, said Mark Haefele, chief investment officer of Global Wealth Management at UBS.

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With equities mainly driving growth in most portfolios, UBS also pointed out that the MSCI All Country World index has had an average annual return of 8% total return US-dollar terms since 1998, "meaning investors have doubled their money roughly every 10 years."

UBS said while private investors need cash especially as they enter or near retirement, it believes they hold "too much" of it. UBS said a survey in the fourth quarter of 2020 showed that its average client holds 25% of their wealth in cash and cash equivalents.

The investment bank outlined an example of an investor with a $5 million portfolio and an annual expense of $250,000 that's rising by 2% each year because of inflation. "Keeping the portfolio in cash would halve its value in just 10 years. Any further uptick in inflation would increase the erosion of real purchasing power."

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Data on consumer prices in January are due on Wednesday from the Labor Department. In the 12 months through December, inflation rose by 1.4%.

Read more: Credit Suisse says to buy these 16 'highest-conviction' stock picks that are set to outperform despite the market's contrarian view

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