JOHANNESBURG – Balanced funds have steadily increased their cash holdings as the local market continues to test new highs.
Duane Cable, portfolio manager at Coronation Fund Managers, says the cash allocation in its Balanced Plus Fund is probably as high as it has ever been. At the end of March 19.4% of the fund’s holdings were allocated to local cash whereas 0.8% was tied up in international cash.
In a normal cycle, one could expect a cash allocation of around 5% to 10%, he says.
Cable says this higher than normal allocation reflects their concerns around valuations in the local market. While they still find global equities attractive and are using most of their offshore allocation (balanced funds are allowed to invest 25% of their funds in offshore equities), they don’t really find value in government bonds or domestic equities.
“Overall, we think the [local] market is quite full. We’re struggling to find value in our market, but obviously there’s still stock specific opportunities which are reflected in our portfolio, but hence you are then left with quite a chunky cash balance.”
Cable says as an asset allocation tool, cash is quite an underrated asset class.
Although the returns on cash are currently not that great, and one can reasonably expect negative real returns over the long-term, cash provides “firepower and flexibility” when the market corrects.
While they aim to outperform the market and provide real returns to clients, they also need to protect clients’ capital. In a market where valuations are quite full at the moment, it is prudent to hold higher cash balances than normal, he says.
As the market sells off the higher cash allocation would allow them to deploy capital into “return-enhancing ideas” should they become available.
Cable says with the market running like it has, the biggest danger is to allow cash to burn a hole in your pocket. People want to be fully invested while the market continues to surge, but given their concerns around market levels it is more prudent to have more cash to provide a cushion against a correction.
Higher but not highest
At the end of March this year, Allan Gray’s Balanced Fund had a total cash exposure of 16.9% (13.6% local, 3.2% international and 0.1% in Africa).
This is slightly higher than the average total cash allocation in the fund of around 14% since inception, but still considerably lower than the level of almost 25% reached in late 2009 as well as in mid-2001.
Simon Raubenheimer, portfolio manager at Allan Gray, says they are finding fewer opportunities in the other asset classes they can pick from, which explains the higher than average cash allocation.
At around 49 000 the JSE’s All Share Index (Alsi) is at a high following a decade of average annual returns of around 20% and valuations are high.
“So I think naturally we look at that and we become a little bit concerned.”
Raubenheimer says over the last five years the market has basically tripled – valuations are stretched, price-earnings ratios are high and dividend yields are low compared to history.
“Remember that to you as an investor the most important determinant of your future return is the starting price you pay for a company today at the point of investing. So the fact that valuations are high doesn’t bode well for your future returns.”
Although the Alsi has underperformed the world market in US dollar terms since the peak in 2010, Raubenheimer still believes there is sufficient cause for concern.
In terms of their bottom-up forecasts (that focus on individual stocks and not on economic or broader market movements) investors would be lucky to get low single digit returns in real terms from the Alsi over the next three years, assuming the market does not derate too aggressively, he says.
The shares in its Balanced Fund (which have large holdings of Sasol, British American Tobacco, SABMiller and Standard Bank) are companies they believe will outperform the average company on the JSE over the next couple of years.
PSG Asset Management also follows a bottom-up approach.
Paul Bosman, fund manager at PSG Asset Management, says every security they buy needs to deliver an expected return that exceeds a hurdle rate. The hurdle rate is typically inflation plus a premium that is related to the risk of the instrument.
“If we don’t find such opportunities, then we will by default hold cash.”
Bosman says at the moment they are finding reasonably few opportunities in both domestic bond and equity markets.
As far as domestic nominal bonds are concerned they don’t currently find any opportunities and only a few opportunities on the floating side of the market.
While there are lots of high quality companies in the local market, many of them are currently just too expensive, he says.
Its balanced fund had a total cash allocation of 29% at the end of March.
Bosman says since the fund does not follow a top-down (macro) approach it does not have a target cash allocation, but a broad estimate would suggest that an average cash allocation would be somewhere around 20% to 30%.
However the cash allocation in the fund has been quite a bit higher previously, touching 50% in early 2010 and 2011.
Bosman says their relatively higher cash exposure (compared to a number of other balanced funds that are sitting close to 20%) could be related to the absence of listed property in their portfolio and their cautious stance on nominal bonds.
They also have relatively limited exposure to consumer related stocks such as retailers. Although they hold Anglo American and have some marginal resource exposure otherwise, they are also quite careful as far as resources are concerned.