Don’t be afraid of cash

I wrote last week about the many ways in which traditional long-only' fund managers are institutionally prevented from performing as well as they should given their above-average intelligence and ample resources.

But there was one thing I left out: the majority of fund managers never hold cash as an asset class; they don't consider it to be part of their job.

As far as they are concerned, if their fund says Europe' on the label they must always be fully invested in Europe. If they were to do anything else, they would not be earning their fees (not that a huge percentage of them do, anyway).

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After all, how many clients would be prepared to pay their fund manager a fee to make a guaranteed loss of a couple of percent a year in real terms, which is the effect of holding cash at the moment? Choosing to hold cash would also constitute an asset allocation decision, and in the eyes of the average fund manager this is a job for their clients. If clients don't want to be in large European companies or emerging market bonds, they should sell the fund. The fund manager's job is to pick individual securities.

Old hands in the market will remember when Eclectica's Hugh Hendry was running the Odey Continental European Fund, and infuriated his competitors so much with his success (based as it was on holding not just equities but cash and bonds) that they lobbied for the fund to be declassified from being a European fund at least, and preferably an equity fund too.

That may not have been an unreasonable case to make. But by the same token, what of the legions of absolute return' funds on the market, to say nothing of the balanced' funds, all of which surely promise an element of asset allocation in their names? They should be more willing than they are to hold cash when they consider it to be a good time to do so after all, their clients are paying for their expert opinion on the merits of different assets classes at any one time and cash is an asset class.

It isn't just individual funds that veer away from cash - the industry as a whole is also very keen to encourage us all to be fully invested at all times. It isn't good for them for us to be sitting around with our money in savings accounts losing money to inflation, as opposed to being in investment funds and losing money on fees. Hence the regular press releases pointing out the difficulty of timing the market and the hideous long-term results of being out of the market on the two, four, five or perhaps ten best days of the year. The propaganda works; almost all investors avoid holding cash.

Ask anyone with a neat nest-egg sitting in the bank how they feel about it and they'll answer that they're mildly guilty that it isn't "working" for them. But the truth, I think, is that being able to sit in cash without having to put up with snide remarks about being paid to do nothing is yet one more factor that gives the intelligent private investor an edge over the intelligent institutional investor.

The key to this is to think of cash as offering what economists like to call optionality'. Sure, it hasn't been a comfortable thing to hold over the last six months as markets have frothed and bubbled and inflation has eaten away at its purchasing power. But great fortunes don't rest on holding what other people are holding at the top, they rest on being able to buy what other people can't afford at the bottom.

I spoke to James Montier of GMO at the London Value Investor Conference a few weeks ago, and asked him how much cash he holds.

The answer was that his own assets are in the GMO Global Real Return Strategy Fund, one of the few that is comfortable holding cash. Right now, it is awash with the stuff, because at the moment a good many markets are "priced as though nothing bad can happen". Which is silly.

It is impossible really to know where markets will go in the short to medium term, barring the recognition of the clear correlation between quantitative easing and rising market returns, and my guess is that anyone fully invested in equities last Monday rather wished they had had some cash by Friday.

On to the good news. There are some funds that you can rely on to regularly use cash as part of their asset mix. One is our old favourite Personal Assets Trust (PAT), which is currently 18% in cash (10% in sterling and another 8% in the most safe haven' of all currencies, the Singapore dollar). Add in index-linked US government bonds and gold and the trust is over 50% in cash and what the industry calls "cash equivalents."

The trust hasn't had a great year relative to the global growth sector as a whole, but ask a long-term holder and you will find that they don't care: the manager's careful asset mix has seen the fund produce stable and superior returns over the long run (up 54% in the last five years).

That's why it still trades at a premium of 1.5% to its net asset value. The other to look at is the CF Miton Special Situations Fund run by Martin Gray and James Sullivan. It isn't cheap (the annual management charge is 1.5% and the total expense ratio TER) rather higher than that) but it is currently around 20% in cash and, like PAT, has a history of producing good but not volatile returns. Which is what we all really want.

This article was first published in the Financial Times