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Press Offices > Asset Managers

Foord Asset Management
Press Office Feature : The role of cash in your investment portfolio

Company: Foord Asset Management
Author:Catherine Pate
Email:[email protected]
Posted:19 Apr 2016

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Market recoveries often deliver the best investment returns

People often use the phrase “cash is king” in times of uncertainty when the best perceived strategy is to sit on your cash until uncertainty fades.

According to Daryll Owen, deputy chief investment officer at Foord Asset Management, cash plays a pivotal role in the effective management of an investment portfolio.

“In investment speak, cash broadly refers to money placed on short-term, variable rate deposit with reputable banks that it is readily available for use.

Because banks face their own liquidity risks and may ultimately fail, cash is a not a risk-free asset class,” says Owen.  “However, it can be considered to be low risk because it is free from most other investment risks.”

“Risk is generally defined as the permanent loss of capital and we strive to grow investors’ real wealth in the long term. A meaningful cash allocation can help with both of these goals at different times in the investment cycle, while providing utility in other areas as well.”

Owen says that we all experience the natural tendency to defer purchases (spending in general) and to hoard our cash when we are feeling nervous about the future.

“In much the same way, portfolio managers faced with increased risks or uncertainty are able to increase a portfolio’s cash component to levels they feel appropriate in the prevailing circumstances.”

The Nobel Prize-winning economist Harry Markowitz once called diversification the only “free lunch” available to investors. In other words, diversification can deliver benefits over time at no additional opportunity cost.

“Cash has proven to be the best diversifier of stock market risk relative to other defensive assets and this first benefit alone justifies its inclusion in any portfolio - the more conviction you have, the less diversification you need. Accordingly, the cash weighting in a portfolio comes down to the portfolio manager’s judgement.”

“Next,” says Owen, “consider the role of cash in combating the effects of inflation. Inflation corrodes investor wealth over time and epitomises an ever-present and meaningful investment risk."

"The cash that is held in your portfolio earns interest at the prevailing rate and the yield that you earn will typically track upwards as interest rates rise in response to rising inflation."

"In the medium to long term, cash will never provide a meaningful inflation-beating return on its own but it should work to maintain the purchasing power of one’s capital.”

Studies show that investors often sell part or all of their investments after a strong market correction and are slow to reinvest after markets have bottomed. These early periods of market recoveries often deliver the best investment returns and missing out on these periods can impair long-term performance.

According to Owen, to participate in the upside of a market recovery, one needs additional cash. Excluding leverage, holding cash in your portfolio through the cycle will provide the liquidity needed to invest in growth assets at the bottom of the cycle, when the risks are lowest.

The cash exposure would also moderate the volatility experienced by the investor by mitigating the extent of the market corrections on growth assets such as shares and listed property.

“The disadvantage of cash is that it may curtail the portfolio’s investment performance in the short term. When securities markets are advancing aggressively, cash will typically be the worst performing asset class over the measurement period. This underperformance is known in industry jargon as ‘cash drag’.”

“Cash therefore provides stability and a solid foundation for an investment portfolio, diversification benefits relative to other asset classes, protection against potential rising inflation, portfolio liquidity and the ability to take advantage of increased volatility,” concludes Owen.

 

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