4 Reasons “Going to Cash” is Not the Best Strategy During Market Volatility
June 27, 2019 By Sage Advisory
by Rob Williams, Director of Research
At Sage, we are tactical managers that make adjustments to our portfolios as the market environment changes. What does this mean? We believe there is always a beneficial market segment to be in; we believe in staying invested. While we have the flexibility to hold some cash in our portfolios, it’s a route we would reserve only for large market draw-downs (think the 2008 financial crisis). For us, choosing the right market segments is more important than repeatedly trying to time short-term market pullbacks.
The following are four reasons why “going to cash” during market corrections is not the best strategy:
1. “Going to Cash” is not an active risk management tactic.
Cash is a guess on near-term market direction. It is often not the best defense in a down market and sets up the potential to miss the upside when the market rebounds.
2. Most corrections are short-lived and rebound relatively quickly.
Major downturns happen only every 5 to 10 years, the corrections range between 5% and 20%, and they only last a few months. Since 2010, we have seen four corrections, and they have all followed this pattern.
3. Being “tactical” in asset allocation is about portfolio risk, not individual position risk.
Mitigating portfolio risk can be done with other tools besides cash. The following scenario takes place during the 2011 correction and rebound. Allocation B outperforms because it participated in the upside of the recovery; and, importantly, because overall portfolio risk was similar, it protected just as well during the draw-down.
Both portfolios have similar total risk to market (.5 and .6 beta)
- Beta = volatility or risk of allocation to market, .5 = roughly 50% of downside risk
4. Being tactical means smoothing the ride.
We do this by limiting the potential negative outcomes. Consider the 2011 correction and rebound. The broad U.S. market recovered quickly, with a six-month window from peak to trough and back to peak. Perfect timing of a 50% cash allocation would lead to strong gains; however, considering the risk of mistiming, the range of outcomes is between -4% to +16%, a 21% difference from best to worst. Alternatively, a 50% tilt to more defensive equities had half that spread, with a +1% to +12% range of outcomes, limiting the size of the potential miss and creating a smoother ride for clients.
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