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Cash Is Back: An Active Investment Decision

Cash as an active investment decision in your portfolio

Cash is a compelling asset class once again, after roughly a decade of unimpressive returns. Investors should be thoughtful about their cash management goals and how to meet them.


A cash management allocation acts as a complement to traditional fixed income investments by providing reduced risk, less volatility and enhanced liquidity relative to riskier assets, as well as a decent risk-reward trade off in today’s environment. Customizing a cash strategy with defined parameters and asset transparency allows investors to feel secure and prepared to take advantage of potential opportunities to come.


We spoke with Piton Investment Management who specializes in designing and managing tailored fixed income separately managed accounts for institutions, RIAs, and high net-worth individuals to walk us through the compelling argument of why cash makes more sense now and how to best allocate to it.


Why Cash Now: Economic Trends


Lofty Equity Market Valuations and a Flat Yield Curve


The current late-stage economic cycle requires prudence amidst lofty equity market valuations and a flat yield curve. The fourth quarter of 2018 showed us how quickly returns can be wiped out as broad market indicators, the S&P 500 Index and the Dow Jones Industrial Average Benchmark lost 9.18% and 8.66% respectively, in the month of December 2018 (Source: Morningstar). Despite the recent moves seen in the month of May, the risk market rebound thus far in 2019 may pose even more risk for investors, as credit spreads in riskier bonds have fallen and equity markets have risen sharply.

Dedicated Cash Investment: Secure, Liquid and Decent Yield


Investors should be setting up a cash allocation to help provide safety, accessibility and as much return as possible, until more compelling risk-return opportunities arise. In this environment of uncertainty, with growth expected to slow and volatility expected to rise, cash has become a compelling asset class for investors who are looking for short-term security, relatively less market volatility, and with a view to be in position to take advantage of potential long-term opportunity down the road. A dedicated cash investment offers security, liquidity and a decent yield (for the first time in a long time) as a result of a series of Fed rate hikes which drove the U.S. Fed Funds rate to its current level of 2.38%. After nearly a decade of returns on cash near zero, current yields are relatively compelling in comparison to the yield on a 10-year Treasury note of 2.33% (As of 5/23/2019) and a trailing 12m dividend yield of the S&P 500 of 1.97% (As of 5/23/2019).


Cash Allocation Strategy


Once the decision is made to invest in cash as part of a strategic allocation plan, investors then need to evaluate the best way to manage that allocation. While the primary objectives of an allocation to cash are consistent, there are multiple distinct uses for cash which require attention and multiple vehicles available to achieve the defined goals.


Individual investors can identify cash in similar fashion to how corporations think of cash management, by:

  1. First identifying the uses of the cash,

  2. Segmenting the cash investment accordingly, and then

  3. Targeting risk and return to meet the defined intention.

Below are some examples of how to think about the different uses of cash which help drive strategic investment decisions.


“Day to Day” Cash

  • Purpose: Used to fund immediate needs

  • Tolerance for Loss: Low

  • Daily Liquidity Need: High

  • Income Generation Need: Low


“Operating Cash”

  • Purpose: Used to fund regular, expected and ongoing needs

  • Tolerance for Loss: Low

  • Daily Liquidity Need: High

  • Income Generation: Moderate


“Core Cash”

  • Purpose: Used to fund intermediate needs; not meant to be dipped into regularly

  • Tolerance for Loss: Low

  • Daily Liquidity Need: Moderate

  • Income Generation: Moderate


“Treasury Chest Cash”

  • Purpose: Complement to traditional fixed income portfolio, used to fund longer-term opportunities, intended to provide market diversification and reduced volatility

  • Tolerance for Loss: Moderate

  • Daily Liquidity Need: Low

  • Income Generation: Moderate


Vehicles of Cash


Depending on the use of cash, there are multiple options available for investors including direct bond investments, money market mutual funds, CDs, high-yield savings accounts, short-duration bond funds and ETFs. For investors seeking off the shelf solutions, there are a number of comingled funds accessible to the masses. However, investors do not have investment direction or influence with these types of vehicles. Liquidity rules are imposed, and valuation fluctuations are uncontrollable.


Personalized Cash Management Solution


For investors seeking a defined, personalized cash management solution, the ideal solution is an actively managed separately managed account constructed with high quality, ultra-short (< 1-year duration) and short term (1-3-year duration) bonds. In this separately managed account construct, investors own the underlying individual bonds which offer a range of yields for different risk levels and maturities.


Investors collaborate closely with portfolio managers to identify the intended cash use and to select a suitable liquidity profile and yield/risk balance. Portfolio managers serve as fiduciaries providing a gateway to the institutional marketplace which enhances investment diversification and offers broader access to the “inventory driven” bond market. Experienced, active portfolio managers consistently review portfolio analytics, efficiently identify and implement changes and provide ongoing direction and advice as individual needs and markets constantly evolve.


Separate account management is how most corporate treasury groups (CFO’s, Treasurers and Finance Controllers), pension plans, foundations, endowments, governments and sovereign wealth funds typically manage their cash. These investors work with fixed income asset managers to organize cash into different categories and then create specific, independent guidelines for their customized bond portfolios.


Special Thanks to Our Contributor

Piton Investment Management provides clients with institutional quality, customized, conservative fixed income separately managed accounts. Piton leverages their extensive experience and market access for the benefit of their clients.


777 Third Avenue, Floor 22

New York, NY 10017

646-518-2800

www.pitonim.com


Brian M. Lockwood, CFA

Head of Fixed Income

blockwood@pitonim.com

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