As readers of my posts will know, I have been a proponent of Index Linked gilts as the ultimate safe haven for UK investors for a long time. The largest single holding in my SIPP (apart from cash itself - currently 13.5% of my SIPP) is 2030 4 1/8% index linked gilts (6.6%). I observe that the "clean price" for these has hit a record high this week @ £286.31. This has certain implications.
Assuming an inflation rate of 4% (over the next 19 years), I calculate that the real redemption yield on these (i.e. the annualised return, including coupons and ultimate redemption on maturity, after RPI inflation) is now just 0.4%. With a 2% inflation assumption that becomes 0.39%. With a 6% inflation assumption it's 0.41% - so not much sensitivity in the real yield to inflation.
What the market is saying is that (on average) over the next 20 years it expects a very low real rate of return for cash. It could also be an expression of fear of runaway inflation in the short term. Over the last year these instruments have risen by almost 14%, whilst the RPI has increased by 5.0%  . That's an excellent return in itself - and I have been reducing my holding over the last few months to take advantage of these gains* and as the redemption yield has become less attractive. This shows that the expectation of low real interest rates over the long term in the UK has increased significantly.
Either way, it surely implies that holding a large proportion of your portfolio in cash is not a "safe" thing to do, in the long run? Unless, of course, you expect an imminent crash in the markets and that you will be able to take advantage of it. Anyone that went to cash in July 2007, and has stayed there, will have seen a negative real return on their cash. RPI has risen by over 14% in that period. The yield on the index linkers suggests that this situation is going to get worse.
My conclusion: unless you are confident that you can pick the right time to re-enter the markets (and many missed the bottom in 2009 and were warning that markets could continue to get much worse), simply staying in cash is not a safe option. Nevertheless, there are clearly significant risks out there: sovereign defaults and/or a Chinese "hard landing". For UK focussed business we also have the risk of fiscal austerity and government job losses bringing the economy to a grinding halt. It is my experience, however, that often these events (which "everyone" feels are imminent) take much longer to occur than expected. Staying in cash whilst waiting for the "inevitable" is not necessarily the safe thing to do, however, being fully invested is equally dangerous.There are no easy answers. I try to take a balanced approach.
*That's a natural consequence of my asset allocation strategy. As the price rises and the proportion of my porty invested in these gilts increases I am compelled to sell some, to maintain the desired balance.
The author may hold shares in this company, all opinions are his own and you should check any statements that appear factual and not rely on them before making an investment decision. The author is NOT a qualified analyst nor authorised to give investment advice. Whilst the author is a director of ShareSoc, all views expressed are entirely his own and not necessarily those of ShareSoc.