Negative real returns on cash have conspired against the asset class in the recent past but geopolitical fears and signs that the bull market is running out of steam means investors are now reconsidering their allocations.
In its October fund manager survey, Bank of America Merrill Lynch revealed average cash balances were 5.1%, well above the 10- year average of 4.5%, suggesting investors are bearish, the bank stated. This dropped to 4.7% in the November survey but allocation was net 31% overweight, still well above the long-term historical average of 20%.
A record 85% of respondents believe the global economy is late cycle, 11 percentage points above prior highs in December 2007.
In the UK, the largest positive shift in sentiment of any asset class during Q3 was towards cash, according to a Last Word Research survey of discretionary fund managers, fund of funds, private banks and other professional investors.
While cash and money market allocations were neutral in July, by October 39% of respondents said they planned to increase exposure and 37% were sitting tight.
In contrast, developed market government bonds suffered one of the largest negative sentiment shifts, surpassed only by US equities and emerging market corporate bonds, highlighting the relative lack of appeal of alternative defensive assets.
Thomas Miller Investments describes its 5% allocation at the end of October as neutral, while Miton’s multi-asset fund range has a relatively high allocation of 10-15%. Cash allocation at Thomas Miller Investments has reached as high as 12% in the past, whereas Miton Cautious Monthly Income hit 18.8% in June 2013.
Equities play into the rationale for both allocations, and Miton fund manager David Jane states that relatively high levels of cash reflect recent sales within equity and the lack of particularly attractive opportunities in fixed income.
In contrast, Thomas Miller Investments reduced a recent cash overweight in order to scale back its equity underweight during the October sell-off, according to portfolio manager Sam Buckingham.
Geopolitical risks, such as the Italian stand-off with the European Union over its budget, plus sharply rising government bond yields hitting company valuations via a higher discount rate, meant markets oversold, says Buckingham.
Overall, Thomas Miller is increasingly adding to defensive assets to protect clients from more volatility and market corrections. “This can result in missing out on some of the upside during market rallies but, to us, this risk-reward trade-off is asymmetrical as the end of the cycle moves nearer.”
Traditional defensive assets misbehave
Cash levels in the Whitechurch Securities core model portfolio range are within a normal range, says investment manager Amanda Tovey.
“We have not decided to increase cash levels in an attempt to time the market as conditions become more uncertain. Instead, we are looking at ways to further diversify and add resilience to our portfolios.”
However, traditional defensive assets are not behaving as they have in the past. The Bank of America Merrill Lynch global fund manager survey shows net 50% of respondents are underweight bonds. It is still below the record low of 69% set in February.
Quilter Investors has an 18% cash allocation in the Wealthselect range’s moderate risk portfolios. “At this stage of the cycle traditional fixed income offers little value and so we tend to opt for cash, which also gives us the ability to act quickly during volatile markets,” says portfolio manager Stuart Clark.
Rathbones multi-asset fund manager David Coombs says he has been spreading defensive assets more widely as the real yield on 10-year gilts is at -1%. Coombs has increased cash in the multi-asset portfolio funds’ “defensive basket”, which is meant to protect clients when trouble hits markets. The basket also contains put contracts on the S&P 500, safe haven currencies such as the yen and Swiss franc, gold and foreign government bonds with higher real yields than those on offer in the UK.
Miton holds short-dated bonds or gilts as an alternative to cash when allocations are high and likely to be held for an extended period. At Cornelian Asset Management, defensive allocations include the iShares Ultra Short Duration ETF, which yields 1.2% with a total expense ratio of 0.09%, and the Twentyfour Absolute Return Credit Fund, which targets Libor +2.5%, says senior investment manager Richard Stark.
Whitechurch Securities has been adding to US government bonds in its core range but Tovey says the team is currently seeking alternative options for its ethical range.
The exclusion is due to the amount of spending on arms and defence and the smaller amount on welfare and social costs.
Architas has added to funds held in its Diversified Real Assets Fund in aircraft leasing, catastrophe bonds and infrastructure for diversification and inflation protection. However, they don’t offer the liquidity of cash, says deputy CIO Sheldon Macdonald. “The way you access them is through investment trusts that can bring its own set of risks in terms of liquidity and the price moving differently to the underlying assets.”
Money market products
Architas uses short-term money market funds for cash allocations noting custodians are increasingly charging for cash above certain threshold levels, says MacDonald, estimating this at around £1.5m. Miton holds pure cash holdings via its depositary bank. Cornelian Asset Management does the same. Thomas Miller Investments’ cash sits in a cash account on the SEI platform that its model portfolios are held on.
Whitechurch Securities does not use money market funds but Tovey says there are options available that run negative screens for tobacco and arms, to which non- ESG alternatives may have exposure via commercial paper.
The Architas multi-manager team uses the £16.1bn JP Morgan Sterling Liquidity Fund, which charges 0.21% and yields 0.58%, according to its latest factsheet, and the £36.4bn Blackrock Sterling Liquidity Fund, which charges 0.21% and yields approximately 0.6%.
Macdonald says: “We find some comfort in using the larger players. They are less subject to being pushed around by in- and outflows from their funds. They’re able to access a wider range of deals or opportunities than the smaller players.”
Certificates of deposit are the largest holding in both products, accounting for 22% of the JPM fund and 34.7% at Blackrock. Asset-backed commercial paper, non-negotiable time deposits, government debt and repurchase agreements also feature highly.
Exchange-traded funds (ETFs) are another alternative for cash-like exposure, although there are only 13 ETFs in the Morningstar money market category available to UK investors. Six of these launched in 2015, while the remainder were launched between 2007 and 2008. The largest available to UK investors is the £907m Lyxor Smart Cash ETF, launched in May 2015, according to Morningstar data.
Money markets are one of the few asset classes where active ETFs are preferred to passive, says Morningstar associate director for passives Jose Garcia-Zarate.
“The macro conditions mean there was not much point for ETF providers to come up with pure passive products tracking money market rates when no one is going to buy them,” he says.
The few that have been successful have taken an active approach, he adds. The Lyxor Smart Cash range, for example, focuses on repurchase agreements. “Rates have been so hideously low, in some cases negative, that you need an active approach in order to extract some yield.”
The JPM Ultra Short Income Ucits ETF launched in June with sterling, euro and USD versions of the fund with a TER of 0.18%. The sterling strategy has attracted £51.1m. It follows in the footsteps of Pimco, which also offers an active cash-like ETF.
The bond specialist previously said it expected the price and portfolio transparency of ETFs to lure in former money market fund investors following EU reform, which will introduce floating Navs and stricter gating provisions in times of market stress.
Cornelian Asset Management holds the iShares Ultra Short Bond ETF but, according to Stark, this sits within the credit bucket rather than cash.
At Architas, Macdonald has noticed a rise in ultra-short-duration funds but prefers to allocate lower down the risk spectrum. “You are not there to earn the returns. What you want from that money market fund is liquidity and capital protection. We tend to stick to the lower risk end of the spectrum,” he says.
Financial planning vs tactical cash
For private clients, financial planning requirements are an additional consideration alongside strategic cash allocations. Cornelian uses client money bank accounts for financial planning cash, which is used to drip feed lump sums into the market, for known and unknown liabilities, ad hoc withdrawals and for smoothing regular payments out of the portfolio.
Stark says: “Dividends can be lumpy and come at different points in the year, so what sometimes happens is they raise cash from capital to supplement the income account. That allows a smoother payment profile to the client.”
Portfolios held on platform may face an additional layer of charges for an asset class that delivers little return, says Discus director Gillian Hepburn. “Depending on how the adviser charges are set up, the adviser could be charging on that as well.” Hepburn says there has been a growth in cash management services within the past year filling the gap left behind by platforms, which used to offer a range of deposit accounts when cash looked more attractive.
Octopus Cash is one such example. The platform facilitates customer access to a range of banks and splits pots into £85,000 sums to benefit from Financial Services Compensation Scheme protection. Octopus director of labs Sam Handfield-Jones says terms on accounts range from 35 days to two years, admitting that leaves it unsuitable for tactical cash.
However, he says the service appeals to intermediaries due to its simplicity. “If you are buying a money market fund you’re looking at who are these notes to, what are the terms on the note, whether it is in gilts or cash. It’s inherently more complex than a lot of people want it to be.”
Multi-asset funds that hold securities directly might be more likely to make tactical cash allocation calls than multi-manager funds, says Macdonald. “By making a tactical decision on cash we might unintentionally undo some of the tilts the underlying managers have in place or, potentially worse, doubling up on everything they’re doing. On that basis, we resist making significant moves except in extreme circumstances,” he says.
The lead up to the Brexit referendum is one such example, due to its binary outcome. Currently Architas holds 4-5% in its Multi-Asset Blended range.
Single strategy allocations to cash
There are two schools of thought for single-strategy managers when it comes to cash allocations and Architas does not have a bias towards either, says Macdonald.
“Some managers will take the view that they manage a UK equities fund and they are being given money to invest in UK equities, therefore the mandate they have is to be fully invested in UK equities.”
That is the conventional approach, he says, but others argue their mandate is to deliver the best risk-adjusted returns, and cash can be part of that.
Sanford Deland tops the UK All Companies sector for the funds with the highest allocation to cash, with both the Buffettology and Free Spirit funds holding around 16%.
Free Spirit manager Rosemary Banyard previously told Portfolio Adviser she prefers to hold cash rather than paying too much, noting the UK is currently expensive based on her discounted cashflow modelling. Architas will assess managers that aggressively allocate to cash for their track record on taking a top-down view, Macdonald says.
