Managers up cash, awaiting opportunities

Cash and other defensive assets are creeping up in some multiasset credit and fixed-income portfolios, as money managers look to keep dry powder available and opportunities appear scant.

A number of multiasset credit managers said they have increased cash and other short-dated instruments in their portfolios, noting they do not see a favorable risk/reward trade-off in credit markets right now.

Some have reduced risk because they think opportunities will appear in the coming months and want to hold dry powder in their portfolios, ready to invest as the chance arises.

Richard Ryan, London-based senior fund manager at M&G Investments, said in the current investment environment “where you don't get paid to take extra risk, we don't want to. This is a moment in time we need to display Herculean patience, sit on our hands, (and) think about risk in portfolios.”

The firm's £4.4 billion ($5.7 billion) multiasset credit strategy for institutional investors has a 41.7% allocation to defensive assets, covering cash, liquidity funds, U.S. Treasury bills, short-dated government bonds, AAA asset-backed securities, AAA floating-rate RMB, and AAA quasi- and foreign government bonds. As of March 31, 2016, defensive assets made up 15.3% of the strategy.

David Lloyd, London-based head of institutional portfolio management at the firm, added executives have derisked significantly. “We are happy to sit and wait. ... We can only take advantage of those opportunities when we have ample dry powder. It is reloading the gun for the next opportunity,” and it can be thought of as a “war chest.”

“If we are not seeing the appropriate level of reward for risk, we take it off the table and park it,” said Mr. Lloyd.

But it's not just about expecting new opportunities to arise. William H. Eigen III, managing director, head of the absolute-return and opportunistic fixed-income team at J.P. Morgan Asset Management in Boston, runs a $3.7 billion SICAV fund and a $12.5 billion U.S. mutual fund with institutional share classes, as well as institutional separately managed accounts. His portfolio had almost 30% in cashas of the end of March, compared with about 18% at the end of December.

“If we can't find intelligent things to do with the (strategy) that will pay returns, we are happy to go to cash. I am actually getting paid for cash — 12 basis points year-to-date. Our U.S. cash holdings are actually yielding between 1% and 1.5% and are contributing to positive performance. Cash is not trash anymore, particularly given the large population of negative-yielding securities within the international fixed-income markets,” he said.

Because he is getting paid to keep liquidity in the strategy, “if I can't find things in the fixed-income universe to beat that hurdle, why not hold it?” Mr. Eigen asked.

He has lowered holdings in U.S. high yield to about 50%, down from as much as 70% early last year. “We are not afraid to move it around. We're holding more dry powder not because we expect high yield to crack or there to be a credit event, but because it doesn't merit as much of a large place in my fund as before,” Mr. Eigen said. “There are some decent opportunities — it is not a bad time to hold some liquidity as some volatility is emerging. As an opportunistic manager, you can't be afraid to run into burning buildings. You have got to be ready to attack.”

The executives at M&G and J.P. Morgan both said their longer-term clients understand how they run the strategies, although newer clients might be less accepting of the fact.

Cash and defensive assets are creeping up in other multiasset credit managers' portfolios, but not to such an extent.

Chris Chapman, portfolio manager on the $24 billion strategic fixed-income strategy at Manulife Asset Management Ltd. in London, said the team tends to keep cash below 5% in the portfolio. “We get paid to find investments to put money to work, not just sit in cash.”

Executives have, however, been more defensive in the past year and a half than previously. “But we have been able to find areas of the world where we can put money to work, get paid more than cash, but still keep dry powder for opportunities as they present themselves.” That includes high-quality ABS and sovereign debt around the world and securities such as Danish covered bonds hedged back to U.S. dollars, the base portfolio currency. “We are fully invested with a defensive nature,” said Mr. Chapman.

While some money managers remain fully invested or hold very little cash, they still have sympathy with the view that markets are a bit risky right now.

“There's no doubt that, in terms of interaction with clients, people are of an increased propensity to take a slice off of the upside potential in order to bolster their downside defense,” said Fraser Lundie, co-head of credit at Hermes Investment Management in London. “But at the same time, the search for yield environment has not gone away,” with the front end of the curve particularly difficult to find returns. “In some cases you're paying to be there, whether it be owning cash and being charged custodian fees, government bonds (that are) negative, or simply in terms of the opportunity cost of what you might be doing elsewhere.”

Within the context of his multistrategy credit funds, Mr. Lundie would not hold cash: “Instead of that we operate a mixture of physical assets like bonds and loans, alongside derivatives.”

Similarly BlueBay Asset Management LLP's Blair Reid, institutional portfolio manager in London on the multiasset credit team, said executives “certainly are not of the mind to have a lot of cash in the portfolio. Our view of the world at the moment is global growth is picking up, we think it will be good for risk assets generally,” and assets such as high yield, emerging markets and contingent convertibles should do well.

The primary risk, he said, is managing rate increases in the U.S., but he said portfolios can remain fully invested with a tactically hedged duration. About 80% of the duration of the strategy is hedged, but “rather than moving to cash or targeting particularly very short-dated bonds, which tend to be fully priced, (we) find bonds that are cheap,” he said. The strategy can move to negative duration of up to 2%. “You want to be pretty judicious about how you do it, because there's a cost” to hedging duration, Mr. Reid said. Managers use euro/dollar contracts or 10-year Treasuries, and can also use S&P puts, he added.