Investors urged not to retreat too far into cash amid market turbulence
Investment consultants have warned asset owners of the potential dangers of pivoting too heavily into liquid assets (Timo Volz/Unsplash)
Investors should be wary about pivoting too heavily into liquid assets, industry stakeholders have warned.
A liquidity crunch in private markets, coupled with an increasingly turbulent macroeconomic backdrop, has resulted in a number of large investors prioritising building portfolios’ liquidity.
UK-based single family office Wentworth Hall previously told MandateWire, AOX’s sister publication, that it is selling its portfolio of investments in order to lean “as heavy in cash” as it can.
This, according to founder and CEO Ian Morley, is due to concerns around the stability of the US dollar, as well as growing taxation in multiple countries and enormous levels of sovereign debt.
The Wautier Family Office outlined a similar, albeit less drastic approach, having told MandateWire that its main priority is having “a good liquidity buffer”.
Founder Jean-Baptiste Wautier pinpointed the impact of AI on the global economy, as well as the amount of money being invested in private credit, as two key risks that justify building “defensive and offensive” liquidity buffers.
There is some logic behind this. Richard Smith, senior strategist at Aon, agrees that liquidity reduces the risk of being a forced seller in times of market falls, and also provides the ability to respond quickly as events unfold.
“Market dislocations often lead to mispriced assets, and investors with readily deployable capital are better positioned to take advantage of these opportunities at attractive valuations,” says Smith. “In this way, liquidity is not simply a defensive tool, it is a critical component of active portfolio management, enabling investors both to protect capital and to capitalise on uncertainty.”
At the same time, however, consultants and asset managers warn that retreating entirely into cash will expose institutional portfolios to severe inflationary drag, and propose alternative solutions to mitigating market volatility.
Zuhair Mohammed, head of investment at LCP, tells AOX that given the current economic backdrop, liquidity is “a really important question at the moment” for investors.
According to Mohammed, holding a small portion of cash, or investing in money-market funds and floating rate notes, is preferable to holding long-term government bonds when expecting an inflation increase, as “those [government bond] yields could go up”.
He adds that money-market funds, as short-duration bond instruments, offer both liquidity and a diverse exposure, and are “better than nothing” if you are convinced there’s going to be an equity market downturn or a big correction.
Chris Brown, head of money markets at Insight Investment, concurs and notes that this type of fund offers capital preservation alongside immediate access to cash, which can be deployed quickly when market volatility creates opportunities.
He continues: “Short-term interest rates remain elevated, with expectations that they may stay higher for longer and could rise further. As a result, money-market funds are no longer simply somewhere to put surplus liquidity, they are generating consistent, meaningful income, with returns that can compound steadily over time.”
As an alternative, Mohammed suggests assets that are short in duration, not very sensitive to long-term interest rates and have an inflation-linkage, such as asset-backed securities or working capital finance.
Nuwan Goonetilleke, interim chief investment officer at Standard Life, proposes a mix of high-quality fixed income bonds, as this will give you an inflation plus return. He adds that those who have left their money in a cash ISA for several years have seen negative returns on a real world return basis due to inflation outstripping interest rates.
Thus, for Goonetilleke, “actually holding assets is really what you want to do”.
Regarding whether a cash position alone would offer a suitable defensive strategy, Mohammed says that this comes with huge risks, namely that you do not put it back into the markets at the right time.
While he acknowledges that a family office may have an in-house investment team to monitor the market every day, for other types of investors, the quarterly cycle will not be sufficient.
“Keeping the powder dry sounds like a good plan until you realise something like cash is going to eat up the true value,” he says. “It may not lose as much as the equity markets, but it’s not going to be a winner.”
Smith agrees, adding that investors who move entirely into cash risk missing the early stages of any recovery, which can have a meaningful impact on long-term returns. As a result, he recommends that investors stay invested, while incorporating liquid diversifiers and private market exposure in a way that manages downside risk and maintains exposure to return opportunities.
Mohammed is reluctant to state what allocation he would recommend for liquid assets, as this would generally differ for each investor. He does, however, say that long-term investors such as family offices might hold 10 to 15 per cent liquidity.
He adds: “I would need absolute bravery pills to go beyond that, because of the chance of being wrong.”