by Adrian Grey, Head of Fixed Income, Insight Investment
In late 2006, it was probably fair to say that most people had little idea what a sub-prime mortgage was, and even less that any problems with them would cause massive knock-on problems. Today, it is difficult to avoid the subject. The sub-prime mortgage market was not necessarily the cause of today’s increased volatility, but more a symptom of a market where a combination of decreasing risk aversion and massive leverage created a fragile equilibrium.
The past twelve months have seen a marked increase in investor nervousness, particularly since the start of 2008. In this environment, investors not only tend to increase their exposure to ‘safer’ assets, but also look for reassurance that their lower-risk investments really are lower-risk.
Cash – a growing market
Cash and cash-plus investments are naturally interesting at present. With the exception of government bonds, the past few months have seen falls in all major asset classes, including equities, property, corporate bonds and emerging market debt. While we believe that these falls have been indiscriminate in some areas, leading to several attractive opportunities, there will undoubtedly be further volatility and investors will be looking to minimise the impact of this on their portfolios.
However, in addition to a cyclical increase in attention, these areas are also seeing a secular increase in demand. Companies have become much smarter about maximising returns on all assets, even short-term cash holdings, and there are now a number of liquidity fund ranges that offer one-week LIBID/LIBOR-type returns. In addition, the growing use of Liability-Driven investing (LDI) strategies is also prompting demand for LIBOR-based returns vehicles, as the swaps used to hedge interest rate and inflation risks are usually funded by 3-month LIBOR.