As central banks come under pressure to set interest rates low to stimulate economies and keep national debt at a manageable level, investors with cash holdings face the risk of negative real interest rates as inflation may outpace deposit returns.

There's a risk that global investors aren't taking enough account of how their portfolios are threatened by negative real interest rates, according to UK wealth manager St James’s Place. 

Martin Hennecke, head of Asia and Middle East investment advisory at the firm, said investors should take negative rates into account when they review investment strategies.

“Central banks are under enormous pressure to keep interest rates artificially low to keep national debt manageable,” Martin Hennecke, head of Asia and Middle East investment advisory at St James’s Place, said. “Investors should be mindful of the threat of negative real interest rates not just in the US but also other major global economies such as Europe and Japan.”

The UK has been cutting interest rates, yet inflation came in at 3.8 per cent last month – an 18-month high. Japan’s headline inflation rate is 3.1 per cent but the Bank of Japan rate is still 0.5 per cent – the widening negative real interest rate is a global phenomenon.

Central bankers and politicians will not openly say that high sovereign debt levels incentivise artificially low interest rates which can pose a risk to savers. Such a policy of "financial repression" is designed to force citizens to hold wealth in riskier assets than cash, with the goal of trying to boost an economy and shrink debt. A problem, critics say, is that negative rates can destroy real capital growth in the long term and encourage firms, for example, to engage in financial engineering through share buybacks and other moves instead of investing in services and goods. Ultra-low/negative rates have even been blamed for producing "zombie" companies that should have gone out of business, been recapitalised or been broken up. See analysis here and here. WealthBriefing's editor also wrote last year about how negative interest rates are a cause for concern.

Hennecke said a potentially widening negative real interest rate environment poses a significant threat to investors in assets which are not positively aligned with inflation. Whilst cash may seem safe due to the absence of volatility, exactly this same feature can make it dangerous for investors with over exposure because value erosion happens gradually it is often only recognised when it’s too late, as money is being spent later and the realisation hits that costs have gone up such as education fees doubled.

This risk can be likened to the experiment done with a frog being slowly boiled alive in a pot of water whereby the danger does not register with the frog when the temperature increase happens very gradually like inflation starting with cold water.

The wealth manager recommends diversifying investments by both geography, asset class, and style, being mindful of the fact that each asset class will be subject to different types of risk, how it all fits together and will be resilient in different economic scenarios including various ‘tail risks’.

Whilst the US has been a popular market over the past years, concentration risk/tech dominance in major indices and valuations has increased, the firm continued. Opportunities in other markets at lower relatively valuations should not be overlooked, such as emerging markets trailed the US for the better part of ~15 years but could stage a comeback, and there can still be some opportunities in Japan and Europe, as well as smaller cap stocks globally.

Long-term, St James's Place thinks equities tend to be an inflation-proof asset class, but it’s important to be able to put away monies for the longer term to be able to ride out swings, accept a degree of volatility and not be swayed by recency bias when selecting equities investments. Investors should look for opportunities in a process-driven way, underpinned by valuation and a sound diversification strategy.

(Editor's note: Artificially low rates push up asset prices, which benefits those who already own assets such as commercial and residential property, equities, forms of debt, etc, but hurts those reliant on a fixed income, or who haven’t yet got near to acquiring assets. Much of the current anger about wealth inequality that drives the angry populist movements in the West can be pinned on this effect.)