Friday, March 6, 2009

When “Cash” Is Not Actual Cash

One of my callers on the radio today had a curly question about his superannuation. As we all know, the value of our super has taken a massive hit as the sharemarket has lost around half of its value in the past year or so. As a significant proportion of our super is tied up in shares it has also suffered, although not as dramatically because of the spread of investments across a range of classes. Super funds also benefit from active management meaning that as conditions change, some of the money can be shifted away from poorly performing investments and into better ones. This is limited by the rules of the particular fund in question so that a fund which is marketed as a share fund must maintain a certain proportion of its investments in shares. That’s why most super funds also offer their customers the choice of a range of funds, and the ability to switch from one to another.

Being a sensible bloke, my caller has already instructed his super fund to switch his investment out of the sharemarket based fund and into the fund described as the “Cash Option” fund. The idea was that rather than being exposed to any further deterioration of the sharemarket, his money would be invested into interest bearing cash deposits. Even though interest rates are also falling at present, the point would be that the actual money invested would be held as cash and therefore would not lose any value. Quite simply, it is a defensive investment strategy which many people would find suitable for uncertain times.

Unfortunately, even after making this change into the “Cash Option” fund, my caller was told that the value of his superannuation investment was still falling, and he wanted to know why. The whole reason for choosing the “Cash Option” was to preserve the value of his investment, but that wasn’t happening. This situation illustrates a pitfall which has a direct connection to the very things which caused the financial crisis in the first place, and it is this: cash is not always actually cash.

In this case it turns out that only around 10% of the money is actually deposited in interest bearing bank accounts. The rest of it, approximately 90% of the money in the so called “Cash Option” fund, is invested in something called a cash enhanced fund. So it’s a fund investing in a fund. Well, what about the Cash Enhanced Fund? Surely that is invested in interest bearing accounts? Well, actually no. A big chunk of it has actually been splashed out on something called “Asset Backed Securities” which is a bit of paper representing a collection of mortgages secured by real assets. Is this starting to sound familiar?

Asset Backed Securities ought to be as safe as houses, but the problem is that they are only good so long as the underlying assets actually retain value. In the current financial climate that is no longer the case. In fact, the whole Global Financial Crisis was triggered by a form of Asset Backed Securities which had been constructed upon the foundation of dodgy mortgages, the so called sub-prime loans in the United States, and subsequently bundled, packaged and sold so many times over that they resembled the financial equivalents of Russian dolls. Underneath all the layers there is very little if any actual value.

Now, not all Asset Backed Securities are devoid of value, but the problem is that they are not actual cash. They are a tradable security, and as such their price can rise and fall, the same as shares do. Right now the value of Asset Backed Securities is taking a belting just like everything else. That’s why you can have your money invested in so called “cash” and still be going backwards. “Cash” isn’t always actually cash.

The good news is that some superannuation funds do offer investment options which are actually cash deposits. If your fund doesn’t, and you want to have the choice, you do have the right to move your super elsewhere to a fund which does. Every fund must provide a Product Disclosure Statement, and that statement must spell out exactly where your money is invested. If you don’t like what you read, you are entitled to take action. It is, of course, always a good idea to seek independent financial advice from a properly qualified professional, but it’s also wise to be as well informed as you can.

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