How much cash in times of volatility?

One of the most difficult decisions for a fund manager in times of global uncertainty is to decide how much cash they should hold. Even if the manager feels that markets will grossly under perform it is hard to put a large part of the portfolio in cash because investors are paying them to manage equities.

Take the example of the present situation. Chinese slowdown, commodity price declines and depreciating currencies are taking massive toll on some of the emerging and frontier markets. In particular, economies with commodity focus like Russia, Nigeria and others like Argentina are getting pummeled. Even countries considered to have enough reserves to weather the storm like Saudia Arabia had its own share of scares. The only countries performing relatively better are those that are commodity importers and less correlated with the global economy. In the frontier universe this would include countries like Pakistan, Bangladesh and Sri Lanka all three of which commodity importers.

The problem however is in the fact that equities in these markets are not cheap. Thus a fund manager has 3 options overall. Allocate more to these countries even though stocks are expensive because the global volatility can run for a long period. Second option is to hold cash and try to time the market bottom (if we believe that markets are cyclical and sooner or later commodities will rebound). Final option is to start allocating risk assets to the battered countries from now on because markets always move faster than economic news. The idea is to take some near term hits on the portfolio but make money on the medium to long term.

These are all difficult decisions and just like most other things involving finance more an art than science. So far it seems to me that investors feel that Chinese situation will stay pretty bad and thus commodities will remain weak. As a result, people will continue to put money in countries with strong external accounts, limited fiscal deficit, declining inflation (through lower commodity price) etc. However, as countries like Nigeria and Argentina keep on under performing there should be a point when the prices will too low to ignore.

Asif Khan, CFA

Asif Khan is presently a Research Analyst (Financial Sector) for Exotix which is a frontier market focused investment bank. He has more than 6 years of work experience as equity analyst in both buy and sell side roles across Asian frontier markets. Asif is a CFA Charterholder and has a dual major in Finance & Economics from North South University.

3 thoughts on “How much cash in times of volatility?

  1. In my opinion, the current market realities has created about 2 to 3 camps; investors who are bearish on equities, those who are nervous enough to reduce their equity exposure and those who are bullish enough to play in the long term. I think the 3rd camp is better as ideally, equity investors should have a long term horizon.

    The current decline might be an opportunity to play in certain markets, names and/ or sectors. Timing when the market may bottom out maybe a bit dicey as frontier/ emerging markets, being less efficient, may start to show positive surprises by reversing. Timing for sometime and coming in, though cautiously, should be fine especially when the fund manager is certain the current decline is not based on fundamentals.

  2. I mostly agree with however I dont believe frontier markets especially Pakistani market is expensive. still its at considerable discount to emerging markets (30%, old number). I believe the earning growth is substantial when you factor in CPEC which will create additional demand of cement, steel and both sectors are in limelight. As you mentioned in the article the diminished commodity prices, many industries are enjoying margin expansion such as Autos, Cements, Steel, Auto Parts etc. Additionally, lower oil prices means lower inflation, resulting in expansionary monetary policy. This scenario, on large part, is enjoyed by financial sector which were holding high duration government bond in declining interest rate regime. All in all, this translates into earning growth and re-rating of market multiples.

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