Publications
Partners
While cash is often minimised in portfolios given its lower returns when compared to other asset classes, it is in fact possible to outperform the FTSE/JSE All Share Index (Alsi) while carrying as much as 30% cash.
This is highlighted by the outperformance of the PSG Flexible Fund, which despite this larger-than-conventional cash weighting, returned 13.5% per year after fees over the past decade (to end October) – 4% better than the equity market and well ahead of inflation.
Flexible funds are among those in which higher cash holdings are permitted, allowing them to capitalise on the true value of cash.
Flexibility and firepower
Often, fear and uncertainty create the most attractive (albeit uncomfortable) investment opportunities. A cash holding in a portfolio is key to taking advantage of these.
Cash in a flexible or multi-asset mandate can act as firepower when valuations of quality securities become attractive based purely on poor sentiment. It also acts to buffer market drawdowns without the end investor having to trade and incur tax.
So, while cash positions in a unit trust may be seen as a drag on performance, there are times when significant cash holdings can pay off, even in higher-risk multi-asset funds.
We are willing to hold cash because it effectively expands our opportunity set from risk assets at today’s prices to the prices that will become available on risk assets in the future. Viewed like this, cash plays a crucial long-term role in our portfolios.
Conventional wisdom: minimise cash to maximise returns – but then miss out?
A typical asset allocation approach considers the long-term average returns for each asset class and an estimate of risk based on the historical volatility of these returns.
Holdings in each asset class are then optimised to produce the highest risk-adjusted return for the portfolio. This process – which is widely used to determine asset allocation in multi-asset mandates – is almost guaranteed to restrict cash holdings to a minimum.
This is because cash has the lowest long-term average returns of all the asset classes. The table below shows that over the past 16 years, South African equities have provided an average 6% in additional performance per year when compared to cash.
The simplistic response is to conclude that any mandate with a long-term investment horizon should aim to minimise its cash holdings and have a larger holding in risk assets (in this example equities and bonds).
Despite conventional wisdom, cash has become a very valuable holding for us, enabling us to take full advantage of periods of investor pessimism (or even panic).
This would not be possible with an investment process that prevented substantial cash accumulation by tightly restricting us to pre-determined asset allocations.
Cash is the asset class that we revert to when we find less or no value in other asset classes at that time. We will happily sit in cash until market opportunities arise where quality goes on sale and patience can pay off.
Anet Ahern is the Chief Executive Officer of PSG Asset Management.
