Part 2/2. Investment and IHT newsletter for Financial Advisers | October 2008 Click to go to: Part 1/2

Is it time for cash or courage?

Cash investment strategies ...

Is it time for cash or courage? When the investment world's in turmoil, is cash the best bet? Mark Benson, WAY's Technical Manager, considers the options.

Photo left: John Husselbee (North Investment Partners).

It's hell out there! We are experiencing unprecedented turbulence in the financial markets. Naturally many investors are very reluctant to put new money into equities and so seek the shelter of cash deposits. In recent months, with the retreat of many world equity markets to five year lows, this has undoubtedly been a sound strategy (assuming of course that you find yourself a depositor in a solvent bank – see "Too cautious for cash?" below). However, now that there are signs of stabilisation in the markets and hopes that the co-ordinated banking bailouts are gaining traction, investors are once again considering putting money back into equities and are wondering if we might be at or close to the bottom.

Of course, anticipating the bottom of the market is almost impossible to do and it will only be known with any certainty retrospectively and once we have seen a most likely strong recovery in share valuations. So, by the time it is certain the market has turned any investors still sitting in cash will have missed the boat to some extent. The cost statistically of missing the best 5 or 10 days in the market has been well reported in recent times and the realist must therefore accept that in the long run it is better to have moved back into the market before the bottom is reached than to miss the early (and often strongest) stages of the recovery. The objective for the cautious investor should therefore be to invest when the worst of the volatility is over rather than wait with the almost inevitably futile hope of calling the bottom of the market. Such investors will accept that the portfolio must be subject to some volatility in return for the opportunity to reap the rewards of the eventual recovery, but will want such volatility to be kept to a minimum.

The IFA's dilemma

The investor is of course guided in all of this by the steady deliberations of their Independent Financial Adviser. This poses two very difficult challenges for the IFA:

• When is the right time to advise my clients to move their money out of cash?
• How will I get all of my clients moved within that small window of opportunity?

At WAY we strongly believe that the decisions in relation to market timing should be put in the hands of professional investment managers who are able to concentrate day in, day out, on managing investments, and are backed up by in-depth research and robust and disciplined investment strategies. We offer a wide range of risk-graded fund of funds engaging the skills of some of the best managers in the business. So, the clear answer to the first challenge is for the IFA to select the appropriate fund for the client's risk appetite and to allow the manager to make the call on when to step up the equity risk.

The WAY MA Cautious Portfolio

For the cautious investors described above, who are reluctant to move out of the shelter of a cash deposit, the WAY MA Cautious Portfolio could well be a very good first step back into the market. The fund’s manager, John Husselbee of North Investment Partners, shares the sentiment of such investors and has kept the fund invested predominantly in cash and similar non or low volatile investments during the recent exceptional period in the markets. Whilst John is now actively seeking the best routes to capture the recovery in markets he does not believe that we are out of the woods yet, and does not envisage significantly reducing the cash (and equivalent) holdings in the short-term.

This provides a great opportunity for the investor who is reluctant to dip their toe in the water since they can choose to invest in the WAY MA Cautious Portfolio now in the knowledge that they will be maintaining a significant cash investment for the time being, but will be able to benefit from John’s expertise in timing re-entry to the market. More importantly, this provides a solution to Part 2 of the IFA’s dilemma, since John is able to move assets on behalf of all of the unit-holders simultaneously - ensuring that nobody gets left behind whilst their adviser tries to juggle appointments and despatch application forms and suitability letters.

"Are we there yet" – John Husselbee's view

In a fund commentary on 15th October 2008, John offered his current views on the state of the markets:
"Many of our clients ask if we have we seen the bottom yet? This financial crisis is not over yet by any stretch of the imagination. Everyone wants to know whether we have seen "a" low or "the" low. I have read numerous commentaries, watched webcasts and listened to podcasts in search of an answer for you. There is a small number who are willing to call the bottom of this market but in my opinion they do so with the conviction of a mirage in the desert. My quick poll of opinion is probably best seen as contrarian. Global economic growth will slow and whilst recessions will be the theme of the West, the Emerging Markets of Asia and Latin America can continue to prosper as the major part of the world's growth engine with the easing of the credit crunch providing the lubrication."

"So, are we there yet? Well, if you are an investor your focus is long term and your final destination is not the bottom of the market. Investors look to take advantage of depressed prices in order to add to their investments. The indiscriminate selling last week has created buying opportunities. We are investors and are beginning to invest once more on the provision that the authorities around the globe continue to boost liquidity and restore confidence to the financial markets."

We suspect that these sentiments, backed up by the fund's 44% exposure to cash (as at: 20th October 2008) could persuade many cautious, long-term investors that their money should be more nimbly positioned, within the WAY MA Cautious fund, ready to get back to work in the markets.

To end, I thought that it would be sensible to reconsider the risks of holding cash, some of which have become all too apparent in recent weeks:

Too cautious for cash?

In between last year's run on the Northern Rock, leading to its nationalisation, and the recent near complete failure of the Icelandic banking system, investors will have developed a much keener sense of the real risk of cash deposits. Whilst cash offers a shelter from the market volatility of other assets, it can never be considered a risk free investment. Whilst the risk of default has become all too real in recent months, for the most part it is a risk that is only felt in exceptional circumstances, such as those experienced at present. This risk has been addressed partly by the increase in the Financial Services Compensation Scheme for deposits to cover £50,000, but more importantly by the implicit guarantee by the Chancellor of deposits in UK institutions and the realisation by governments worldwide that a failure of the banking system cannot be countenanced due to the devastating affect it would have on all areas of economic activity.

The other risk of cash deposits which, whilst not felt so dramatically, is an almost constant detriment to cash holdings, is the likelihood of a negative real return to the investor after inflation and tax are taken into account. With UK CPI inflation now at an annual rate of 5.2% (Source: Office of National Statistics figure for September 2008) a basic rate taxpayer must earn 6.5% gross and a higher rate taxpayer 8.67% gross or more in order for the real value of their deposits not to be eroded over time. The basic rate taxpayer could just about achieve this at present, although such high rates have proved themselves to come at the expense of doing business with the most risky institutions. In fact, a negative net return on deposits is experienced the majority of the time over the long-term, further reinforcing the maxim that "when depositing cash you are merely lending and not investing.

Investors who have cash holdings via other financial instruments, such as bonds, pension plans, unit trusts and OEICs have also now realised that they do not automatically enjoy the benefit of the various deposit protection schemes in place around the world. The investor protection for such tax wrappers provides for compensation if the wrapper / product itself should fail, and not for the failure of the underlying investments. So, just as the investor takes the risk that a share held in such a fund falls in value, they take the risk that a cash deposit becomes unrecoverable. Again, this risk may now be somewhat protected by the implicit guarantees in place from various governments in their quest to maintain the confidence and operation of world financial markets.

Such risks are not ignored by our fund managers who, like John Husselbee, will, from time to time, include cash holdings as part of the portfolio strategy. John has recently commented on the holdings in the WAY MA Cautious Portfolio:
"The cash funds in which we invest are rated by Standard & Poor's as AAAm. The 'm' signifies that the funds invest with preservation of principal and liquidity as the priority versus returns for investors. Essentially, these funds invest in very short dated commercial paper and certificates of deposit. The weighted average maturity of these funds as at the end of August 2008 was 32 days for Goldman Sachs, 48 days for BNP and 49 days for Insight."

"To date, these funds have avoided any direct defaults on their investments. Whilst this cannot be guaranteed due to the number of investments held in these funds and their short dated nature, if large losses are experienced in these funds it would have to be as a result of a complete global corporate meltdown."

How to contact us
If you wish to talk to someone about the issues raised in this e-newsletter or about any of WAY's products, please feel free to call either your local Regional Sales Manager or Tony Lyons, IFA Support Manager, head office telephone number: 01202 890895. Or you can use the website: Contact Form to get in touch. We look forward to hearing from you.

- Ends -

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Newsletter: October 2008.

Note: This newsletter commentary has been prepared for Financial Intermediary Clients and Professional Associates of WAY Investment Services Ltd and is not intended for and must not be distributed to Private Investors. This information is supplied to you in confidence and you may not pass it on to any other party without prior written consent. Past performance is not necessarily a guide to future returns and changes in rates of exchange between currencies may cause the value of investments to rise or fall. No representation or warranty is given (express or implied) as to the accuracy, completeness or correctness of the information nor the opinions, interpretations and conclusions contained in this commentary. The commentary does not constitute investment advice or a recommendation to purchase or sell any security. Neither the author nor WAY Investment Services Ltd accept any liability whatsoever for any loss or damage arising in any way from any use of or reliance placed on the commentary. WAY Investment Services Ltd is an Appointed Representative of WAY Fund Managers Ltd which is authorised and regulated by the Financial Services Authority.

Newsletter: October 2008.