Market volatility has prompted a flight to cash, but how much is really appropriate in diversified long-term allocation? Amanda White reports.

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In the past year, one of Australia’s largest super funds, AustralianSuper, has reduced its allocation to equities by a massive 10 per cent as a direct result of all new cashflows being directed to cash. At the same time, one of the largest investment wraps, BT Wrap, reports that its newly listed term deposit product has attracted more money than any other product within the wrap, since inception.

The tumultuous markets are having a profound effect on investment allocations, with a lot of investors being scared into cash. But with all that cash sitting in the bank, the purpose of cash and its role in a portfolio need to be re-examined.

Tim Farrelly, principal at farrelly’s, says cash is only king in down markets because it allows you to buy things cheaply.

“Clients definitely like cash, and they are very nervous about allocating to other assets, given the markets. Cash is king in down markets but it is only king because it allows you to buy things cheaply. Cash is only useful when it is spent,” he says.

While Farrelly concedes the current market volatility represents a “serious crisis”, investors – and their advisers – still need to think in the medium to long term.

“Cash rates are good, but they are still only one-year rates; you won’t get 7 to 8 per cent over 10 years,” he says.

“If anything, clients should be making a change to spending it; now is a good time to buy cheap assets, like equities and property. People are saying they are going to wait until markets stabilise before they allocate, but what they are really saying is they are waiting until prices are 20 per cent higher – that doesn’t make sense.”

Farrelly says a planner can “earn their keep” now by showing leadership – and now may be a good time to buy assets.

“In the long term people have done better assuming it is not different this time,” he says.

“The planner’s job is to lead the client. At the very least planners should be advising that clients rebalance. They need to take a step back and say they are not good at market timing in the short term.”

Certainly it seems the short term market volatility has unnerved some investors who have re-adjusted their risk profiles, and associated allocations, because of the recent turmoil.

But Dante De Gori, technical manager at ClearView Retirement Solutions, also believes that most clients should be adhering to their long-term strategy, and that that strategy should include some cash in the first place.

“Where possible, we advise to stick to the longterm asset allocation, whereas some clients are now changing their perceived level of risk because of the downturn,” De Gori says.

He believes that in a diversified portfolio, unless a client is 100 per cent aggressive, there should still be some cash reserve. “For retirees in particular, having some cash in the portfolio comes into play in times like this, as it allows them to draw down income without having to crystallise any assets and so allow the aggressive assets to do their work,” he says.

“If a portfolio doesn’t have cash and you are forced to draw income from aggressive assets, then the impact is a double whammy for your portfolio.” There is definitely an argument to hold cash, but how much is appropriate is not straightforward, with allocations so dependent on individual situations. But De Gori believes a good aim is to have two to three years of income in cash, which he defines as an asset with no exposure to equities that produces income and that includes cash, cash guarantees and fixed income.

While asset allocation decisions are driven by a client’s personal needs and situation, when it comes to cash allocations, Doug Webber, associate director, Macquarie Wealth Management, who is a financial planner by trade, believes the biggest factor is how long a client has been in, or out, of the sharemarket. “If you have been in the sharemarket for 20 years, then there is no point taking your money out; but just stay with your long-term allocations and ride this out.

With a lot of clients, allocations to cash have probably not changed by definition, but the relative value of equities has decreased because of the sharemarket. We are selectively advising rebalancing if you are a long-term investor because there are some bargains out there to have now,” he says. “If you have been out of the market for five years, we are having a lot of conversations around holding the line; we say don’t get out of equities and dive into cash, but if you have cash, hold on to it and see what happens.”

For Macquarie advisers, he says, the most interesting conversations are with those who have come into cash by some life event and who want to know what to do with it. It becomes a question of how to manage the cash exposure.

“With the market interest rate decrease, then a term deposit is a good way to go because you can lock in today’s rates. Logic suggests term deposits will do well,” he says. And while there is no one-size-fits-all approach, Webber says the advice given to clients is to imagine the worst-case scenario, which is different for different people.

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