Cash policy

Should fund managers stockpile cash?

It’s the focus of heated debates among investors and investment professionals alike. Some money managers simply hold cash in the absence of what they consider to be good investment opportunities. Many disagree. There are good arguments to both sides.

The case for holding cash

Cash policy is but one of the many constraints with which most money managers must deal when structuring portfolios. Some in the industry hold the belief that a manager should not keep her fund fully invested unless she can find a sufficient number of stocks that meet her investment mandate.

In other words, many advocate a flexible cash policy. A fully invested fund would generally hold between two and five per cent in cash. At times, a flexible cash policy in a stock fund could see cash holdings at anywhere from 20 to nearly 100 per cent. The reasoning is that managers should not sacrifice quality purely for the purpose of deploying the fund’s assets into stocks.

In their view, the large cash holding is rather temporary and will be reduced once stocks being closely monitored are priced more reasonably to make a purchase worthwhile.

Gerry Coleman (CI Harbour), Jerry Javasky (Ivy: Canadian, Foreign Equity), Vito Maida (Patient Capital), and Larry Sarbit (AIC American Focussed) are some of the more popular managers that will gladly hold cash if an inadequate number of attractive stocks can be found.

Staying fully invested

People in this camp are strong critics of the flexible cash policy. They argue that investors and financial advisors choose, for instance, a U.S. stock fund out of a desire to have some exposure to U.S. stocks.

Let’s say Bob, a typical fund investor, invests half of his money in one stock fund, with the other half split evenly between one bond fund and one money market fund. With this mix, Bob expects to have about 25 per cent in cash (i.e. via his money market fund), 25 in bonds, and about half in stocks. Suppose that Bob’s stock fund has been unable to find good stocks and, as a result, is about half invested in cash.

When Bob realizes this, he recalculates his “true” asset mix, and finds it to be: ¼ in stocks; ¼ in bonds; and ½ in cash. That’s substantially different than his intended mix. Proponents of being fully invested criticize flexible cash policies because of the impact such policies can have on investor asset mixes. And Bob’s situation illustrates exactly what proponents of staying fully invested are talking about – holding too much cash throws investors’ asset mixes out of whack.

Kim Shannon (CI Canadian Investment), Synergy, McLean Budden, Standard Life, PH&N, and Mawer Investment Management are excellent examples of quality managers who always try to ensure that their funds are fully invested.

Among the respected group of money managers that focus on managing pension and other institutional portfolios, a flexible cash policy is as common as a three-dollar bill. So, it’s no surprise that all but the first two of the “fully invested” managers listed above count pension and institutional money management as the core of their businesses.

My take

I truly believe there is merit to both approaches. On one hand, I’m not nuts about a manager having a large impact on individuals’ asset mix. But then again, I don’t want any manager tossing money at stocks just to brag that he has no “cash drag”.

I tend to sit somewhere in the middle. I absolutely love it if managers can stay fully invested because it provides me with greater control over my asset mix. At the same time, I think giving a fund manager some flexibility to hold large cash positions makes sense – particularly in an environment like we have today

Many value managers continue to struggle in finding new investment ideas because the recent stock market rally has made it that much tougher. I say let managers stockpile cash – as long as they’re not trying to make a top-down call on the markets. Rather, if it’s based on fundamentals and a desire to invest their clients’ money only when suitable opportunities arise – so be it.

Dan Hallett, B.Comm., CFP, CFA is the Senior Investment Analyst with Sterling Mutuals Inc. He can be reached at dhallett@sterlingmutuals.com Sterling Mutuals Inc. is registered as a mutual fund dealer in Ontario, British Columbia, Alberta, and Manitoba.