Fidelity: Why cash isn't always king

Key points

• With UK inflation at the highest level since the 1980s, we believe investors should consider short-dated credit as an alternative to cash.
• Investing in short-dated credit is not risk free, but an active and disciplined approach can deliver a higher level of income for only a marginal extension of risk.
• Launched in 2016, Fidelity Short Dated Corporate Bond currently offers a first quartile yield, first quartile volatility and first quartile fees relative to the broader IA £ Corporate Bond sector.

With UK inflation at its highest level since the 1980s, investors will find that sitting in cash can lead to material real term losses. This is because high rates of inflation erode the real value of cash over time.

To illustrate this, we use current and projected inflation rates to compare the real return of cash, cash savings in a high street bank and cash invested in Premium Bonds over time. We have assumed consensus UK inflation projections of +8.0% year-on-year (YoY) during 2022, +4.4% YoY for 2023 and +2.0% YoY (the Bank of England’s target rate) thereafter. This is arguably a relatively conservative assumption given the Bank of England has repeatedly revised its inflation forecasts upwards in every meeting since June 2021.

Cumulative projected growth of £10,000 after adjusting for inflation

Please note that the above returns are simulated and are therefore not a reliable indicator of future returns.

Source: Fidelity International, Bloomberg, 30 June 2022. Figures show the cumulative growth of £10,000 based on a range of different scenarios after adjusting for inflation. Fidelity Short Dated Corporate Bond (average yield) assumes the Fund yields an average of the YTM since inception and this yield is applied to £10,000 on an annual basis in perpetuity. Average since inception YTM is calculated using monthly data from November 2016 to June 2022. Fidelity Short Dated Corporate Bond (June 2022 yield) assumes the Fund yields the YTM as at June 2022 and this yield is applied to £10,000 on an annual basis in perpetuity. Premium Bonds refers to the interest rate on a leading Premium Bond savings scheme in the UK. Cash (retail bank) refers to an average of three leading retail savings account providers (using AER numbers quoted online). Cash (under mattress) represents the value of £10,000 assuming to positive nominal return after adjusting for inflation. UK CPI used for inflation. 2022 and 2023 forecast for UK CPI uses consensus numbers from Bloomberg and inflation assumptions for 2024 onwards are the Bank of England target (2%) for perpetuity.

The case for short-dated credit

Investors may be able to help offset this real value erosion by investing in high quality short-dated credit, such as the Fidelity Short Dated Corporate Bond Fund. It is important to note that short-dated credit is not risk-free and does exhibit credit and interest rate risk relative to cash. However, by focusing on short-dated bonds (to help reduce interest rate risk) issued by high quality investment grade rated issuers (to help reduce credit risk), investors can still achieve a higher income relative to cash or government bonds for a marginal extension of risk.

If we assume that an investor holds £10,000 in the Fidelity Short Dated Corporate Bond Fund and assume that they earn the average yield on the fund since inception per year over the next 30 years, this would sufficiently protect the value of that cash in real terms. What’s more, given the material rise in yields over the last 12 months, if we assume the Fund returns the latest yield each year for the next 30 years, this would offer a real gain of over 90%. Past performance is never a reliable indicator of future results - and these are assumptions - but the overall message is clear.

Our approach to investing in short-dated credit

We generate an excess yield over the index through a bottom-up, active and disciplined approach. Firstly, we tend to underweight quasi-sovereign and supranational issuers which make up a large part of the universe but offer little in spread and yield terms.

Secondly, in the short-dated space we will add subordinated financial bonds where we get a pick-up in yield and we feel it is appropriate; by focusing on legacy subordinated bonds that are more likely to be called, being disciplined where the issuer has not called bonds in the past and not including bonds with equity-like features (such as additional tier-1 securities).

Finally, we take a highly selective approach to high yield which is capped at 10% of the portfolio. Here, we focus on high conviction names we feel are due to be upgraded to investment grade status, high conviction names we are happy to own over a short time horizon and issuers that fundamentally have investment grade balance sheets.

This approach has helped underpin a strong track record since the Fidelity Short Dated Corporate Bond Fund was launched in 2016. The Fund offers a first quartile yield, first quartile volatility (measured by three-year volatility) and first quartile fees (ongoing charges of just 0.24%*) versus the broader IA £ Corporate Bond sector.

*The OCF is for the year ending 28 February 2022. This figure may vary form year to year.

Important information

This information is for investment professionals only and should not be relied upon by private investors. Past performance is not a reliable indicator of future returns. Investors should note that the views expressed may no longer be current and may have already been acted upon. Changes in currency exchange rates may affect the value of investments in overseas markets. The value of bonds is influenced by movements in interest rates and bond yields. If interest rates and so bond yields rise, bond prices tend to fall, and vice versa. The price of bonds with a longer lifetime until maturity is generally more sensitive to interest rate movements than those with a shorter lifetime to maturity. The risk of default is based on the issuers ability to make interest payments and to repay the loan at maturity. Default risk may therefore vary between government issuers as well as between different corporate issuers. Due to the greater possibility of default, an investment in a corporate bond is generally less secure than an investment in government bonds. Sub-investment grade bonds are considered riskier bonds. They have an increased risk of default which could affect both income and the capital value of investments. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only.