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Professional investors are
raising their cash stakes;
should you?
NEW YORK » Cash. Bread. Dough. Ducats. No matter what you call it, the money you manage to sock away over time is symbolic of past successes and future hopes. So, in a sideways market choked by risk, should you preserve more of your hard-earned dollars in their most liquid form?
Most financial planners agree that cash should account for some portion of your total holdings at all times, preferably in a money market account yielding 2 percent a year. It mitigates volatility, helps cover expenses and may lend you peace of mind. How much cash you set aside depends on the rest of your portfolio, your time horizon and your appetite for risk.
For professional investors, timing plays a role as well. With interest rates rising and the market snarled by uncertainty over everything from inflation, Iraq, the presidential election and concerns about equity valuations, a number of money managers are raising their cash stakes.
The Investment Policy Committee of Standard & Poor's recommended last month that investors boost the cash portion of their portfolios to 30 percent and reduce stock exposure to 60 percent. The previous recommendation had been to keep 20 percent in cash and 70 percent in equities.
"Even though we believe equities still offer a better return opportunity than bonds or cash ... the prospect of higher interest rates increase the risks," said Sam Stovall, S&P's chief investment strategist for U.S. equity research. "By having more cash, that means if we do experience a pullback, then we have money we could put to work."
Higher interest rates usually lead to modestly lower equity valuations for three reasons -- bonds become more attractive than stocks, borrowing costs for businesses rise and the market is forced to discount future earnings and cash flow. At this point, however, with the rate tightening cycle just beginning, bonds aren't looking so hot and equity bargains seem few and far between.
Such "slim pickings" among stocks led Robert L. Rodriguez, portfolio manager of the small-cap focused FPA Capital Fund, to accumulate a cash stake of almost 40 percent, up from about 23 percent at the start of the year. It's not so much that he thinks cash is a good place to be, it's just that he hasn't found much he'd like to buy.
Forecasting a total equity return of about 5 percent over the next five years, Rodriguez shuttered his fund to new investors this month. The last time Rodriguez closed his fund was in 1998, near the peak of the tech bubble. He said he's starting to recognize similar patterns now.
"We're just going to sit tight until something happens," said Rodriguez, who has managed the fund since 1984. "I have great confidence that fear and anxiety will eventually return to the financial markets, and people will have wasted their capital, and we will have not."
Rodriguez is one of a small but growing number of mutual fund managers maintaining hefty cash stakes. According to Morningstar Inc., which tracks nearly 6,100 mutual funds, 162 domestic stock funds have cash positions of 20 percent or more; 88 hold at least 30 percent of their assets in cash.
Liquidity of about 5 percent, certainly no more than 10 percent, is more typical, although some equity mutual funds are required to be 100 percent invested at all times.
For small investors, how much to keep in cash is really "a sleep-at-night kind of issue," said Hugh Johnson, chief investment officer at First Albany Corp.
"There's no question that there is a long list of worries, and it's getting longer, and the returns from stocks are not impressive," Johnson said. "But I would not recommend anybody get caught up in the performance of the markets over the last three months, or the worries, because in time they're going to go away."
Johnson, who remains optimistic about the market's prospects overall, said that although equities are set to return substantially less than they did last year, they'll still yield "the best bang for your buck." He thinks stocks will bring close to 10 percent by the end of the year; bonds will likely yield about 4.5 percent.
In practical terms, it's a good idea for everyone to keep a certain amount of cash in reserve, said Patricia Jennerjohn, head of Focused Finances in Oakland, Calif. Three to six months of living expenses is ideal for regular wage-earners, and retired people should set aside enough cash for at least a year or two. If you've planned carefully, Jennerjohn said, this should make up 5 percent to 10 percent of your total portfolio.
For the average person it doesn't make sense to hold more cash than that, she said. That's because if you are overly cautious, and hold too much in cash for too long, you'll never be able to outrun inflation.
"People forget that inflation, over the long run, is the biggest threat to their portfolio, far more than volatility," Jennerjohn said. "It's the slow rust at the bottom of your portfolio. You don't see it, but it eats up your money. It's insidious. So don't go too crazy with cash."
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