Holding cash, particularly in longer term investments such as pensions, is often seen as contrary to the primary purpose of investing money: to stop the erosion of value due to inflation and thereby make a ‘real return’, be that great or small.
However, both investors and managers may up their cash weightings with the aim of taking advantage of expected short-term market falls.
Sturkenboom says over recent years since markets bottomed out in the wake of the financial crisis, attractive valuations across asset classes and quantitative easing meant staying fully invested was practical.
“In a world of dovish central bank policy, it was easy to dislike cash. After all, central banks clearly signaled yields were going to stay low for a prolonged period of time and simultaneously increased inflation expectations,” he explained.
“[With] the wall of liquidity coming from central banks, the expectation was that volatility in financial markets would fall and stay low, so the element of optionality imbedded in cash meant you had the option to buy something once you consider it attractive.”
“It is really an extension of Buffett’s famous adage that you know who is swimming naked when the tide goes out. Cash is like a swimsuit. However, if you expect volatility in financial markets to fall that option value decreases and the swimsuit is merely bothersome while the tide keeps coming in.”
But with UK inflation at a 14-year low and many managers expecting greater volatility, this is arguably more attractive as there is a slower rate of erosion and potentially more market dips.
The likes of Janus Capital’s Bill Gross has also recently said that returns in most asset classes will be low or negative this year.
Sturkenboom says a combination of higher real rates, increased market volatility and lower opportunity cost “means cash is no longer trash” and he advises investors increase their holdings in cash.
“Having some cash on hand will help dynamically manage portfolios and utilise opportunities. When the US and UK run out of room for non-inflationary growth, cash will become particularly attractive, although lower commodity prices might delay that moment by a quarter or two,” he said.
“In such an environment, the option value of cash is very attractive as it allows the dynamic management of an investment portfolio. 2015 is a year in which we expect having a swimsuit will come in very handy.”
“The continued fall in commodity prices might delay Fed and BoE rate hikes, making cash particularly useful, though given the US and UK are slowly running out of non-inflationary growth potential, any delay is unlikely to last beyond a quarter or two.”
He says there are a number of reasons to be positive about cash.
“Although real yields are still negative, they have been rising over the course of 2014, mostly a result of falling inflation on the back of lower commodity prices. We expect this to continue in 2015 when we anticipate the Fed and BoE will begin to raise interest rates, likely in Q2.”
He adds that, secondly, the opportunity cost of holding cash has decreased remarkably over the past few years with valuations in equities, corporate bonds, real estate and government bonds all rising.
“All of these asset classes have low to negative expected returns, making cash almost painless to hold from an opportunity cost perspective,” he said.
“With the wave of central bank liquidity dissipating now that the Fed has ended its programme of quantitative easing, we expect volatility in financial markets to rise. The ECB looks ready to partially pick up the mantle but it won’t fully compensate for the Fed’s exit; we expect heightened risk awareness around the first couple of rate hikes.”
As well as hiking their own cash, investors can also buy funds with a high weighting to cash in order to advantage of more volatile markets, leaving the decision of when to invest that money to the manager.
FE Alpha Manager Marcus Brookes, who heads up the Schroder MM range with Robin McDonald, has voiced his concerns about the market on a number of occasions over the past 12 months or so and has maintained a very high weighting to cash as a result, which currently stands at up to 40 per cent in the Schroder MM Diversity Tactical fund, the largest weighting in the IA Flexible Investment sector.
In the UK All Companies sector there are just five funds with more than 15 per cent in cash. The largest is the £31m Premier ConBrio UK Opportunities, which has 36 per cent in cash, followed by JOHCM UK Opportunities and MFM Bowland, which have 19.64 and 19.55 per cent respectively.
However, a high cash weighting can impact on performance in rising markets and the three funds have all underperformed both the sector average and the FTSE All Share over three years.
Performance of funds, sector and index over 3yrs
Source: FE Analytics
On the fixed income side there is some even more bearish sentiments from managers with the likes of JPM’s Bill Eigen having a very high cash weighting of approximately 45 per cent, although this has been higher over the past year, up to approximately 70 per cent.
The $1.8bn Pimco GIS Diversified Income Duration Hedged fund, managed by Eve Tournier has seen its cash weighting come down from almost half the fund in November to approximately 20 per cent now.
This hasn’t helped performance of late, however, with the fund bottom of its IA Sterling Strategic Bond sector over one year and bottom quartile over three.
In its sector as well as in the IA Sterling Corporate Bond sector only one other fund has a cash weighting above 15 per cent, the £324.8m Threadneedle Strategic Bond fund which has 42.9 per cent. It is also bottom quartile over one year but has fared better over the longer term, sitting third quartile over three and five years.