The Mechanics of the Cash Option

The recent underperformance of UniSuper’s Cash option has prompted members to enquire about the exact nature of the option. This article aims to clarify the situation and address any concerns you may be having.

The Cash investment option is made up of investments in a highly diversified portfolio of money market securities; including bank bills, promissory notes and floating rate notes such as mortgage and asset backed securities. It aims to achieve returns (after taxes and fees) that are at least 1% p.a. more than inflation (CPI).

Unlike a bank account, the Cash option does not have a capital guarantee. Rather, it provides a low risk investment in bank bills and higher returning cash instruments, and as such is subject to market fluctuations in value. This means that it will not always pay exactly the same as the bank bill rate.

The Option has been structured in this way so that it is most beneficial to long-term super and pension members. By providing exposure to a diversified pool of high quality cash securities it should achieve good, low risk returns over periods of 1 to 2 years.

Over even longer periods, the returns will generally be ahead of a bank account, but as has been demonstrated recently, over short periods, it can have periods of low, but not negative, returns, especially when interest rates are rising.

For the year to 31 December 2007, the after tax and after fees return for the Cash Option was 5.3% versus its bank bill benchmark of 5.7% (adjusted for fees and taxes) or 0.4% underperformance.

It should be recognised that this underperformance has occurred during a period of abnormal market conditions for cash securities, whereby there has been a slight reduction in the value of cash securities relative to bank bills.

These abnormal conditions have been partially created by the sub-prime mortgage crisis in the US and concerns about the overseas banking sector. The impact on UniSuper's option is largely due to the more general fall in the value of cash securities, especially those issued by financial institutions, rather than poor selection of the securities held within UniSuper's portfolio.

Care should also be taken when comparing the Cash option’s returns with returns that can be obtained from term deposits from banks for two reasons. Firstly, the UniSuper Cash returns are quoted after fees and taxes. Secondly the returns for the Cash option relate to a specific period when interest rates were moving up, whereas term deposits relate to future payments of interest (i.e. it is not correct to compare historical returns with prospective returns. A significant degree of yield is built into a cash portfolio, as interest rates rise, but the initial effects of a rate rise is to reduce returns.

It is important also to note that the Cash Option has performed as anticipated during this period of market turmoil. The product remains invested in a high quality diversified portfolio of securities, with very low risk of defaults.

Reassuringly performance, over the longer-term also continues to hold up well. The Cash option return over the last five years, has averaged 0.20% p.a. above the 90-day bank bill benchmark to 31 December 2007.

Additionally, the performance of UniSuper’s Cash Option has also been favourable in comparison to other super funds on an after tax and fees basis. The SuperRatings Fund Crediting Rate Survey showed the UniSuper Cash option was ranked near to top of the survey (7^th/47) over the three year period ending 31 December 2007, and performed in line with its peers over six months.

Published: 20 March 2008