King Cash Gets Dethroned
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Upwards of $6 trillion in client cash – dry powder, you might say – is on the sidelines, and if it's in a high-yield savings account or money market fund, it's happily earning about 5%.
For now, many wealth managers and their clients seem content to whistle past riskier asset classes and make hay while the proverbial sun shines. But some forecast cloudier skies on the horizon.
The federal fund rate has hovered at 5.33% since last July or so, after two years of aggressive interest rate hikes meant to counter historically high inflation rates. The result? Money market fund assets hit a record $6.11 trillion earlier this month, before sliding down to $5.9 trillion as of April 17, largely thanks to tax payments (grr!), according to Investment Company Institute data.
Still, it's a big jump from the $4.5 trillion such products represented at the beginning of March 2022, when the Federal Reserve began its series of interest rate hikes, noted Financial Advisor IQ's sister publication Ignites.
Some doubt the Fed will make good on previous messaging that it will start trimming rates this year, but the prospect has caused some registered investment advisors to reevaluate cash allocations in their clients' portfolios.
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Advisors told FA-IQ this month they are looking toward short-term bonds, value-oriented sectors and real estate investment trusts as the prospect of lowering interest rates threatens the longevity of healthy returns on cash and cash-like investments.
Megan Gorman, managing partner at Chequers Financial Management, said her firm's clients have diversified exposure in fixed income and equities. In terms of fixed income, that means high credit quality municipal bonds as well as international bonds, floating rate and private credit, and extending duration where appropriate to lock in higher yields, she said.
"The best investing is boring. It's like watching paint dry," Gorman said. "As a result, we really need to make sure that we are managing client emotions as we navigate portfolios."
Alvin Carlos, financial planner and managing partner at District Capital Management, said his firm last year shifted from cash to short-term bonds, which he noted are "less sensitive" to price declines during rate hikes. "I think we're going to keep it that way," he added.
Aldo Vultaggio, chief investment officer and partner at Capstone Financial Advisors, said advisors should avoid making tactical moves based on rates lowering "because they might not actually move down this year."
Vultaggio said his firm is talking with clients about real estate allocations, as there has been a "dramatic repricing" in public REITs and private real estate investments.
Meanwhile, Matt Liebman, founding partner and chief executive officer at Amplius Wealth Advisors, and Stephanie Lang, principal and chief investment officer at Homrich Berg, say they're still digging cash.
Liebman said his firm could look to move some money out of cash in the event the Fed starts cutting rates, but for now it still likes the "risk-reward" of higher yielding cash.
Lang said today's rate environment is likely the "best that we will see" in terms of earning money on cash. "Take advantage of it while you can but be ready to make alternative investments once that yield comes down and you can make a better return elsewhere," she said.
Wow, we haven't even mentioned exchange-traded funds yet.
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Yep, There’s Also ETFs
A recent Institutional Shareholder Services study found that RIAs are very likely to move assets from cash to both passive and active ETFs as clients look to reinvest, according to Ignites.
Nearly a quarter of RIAs and 14% of hybrid RIAs, or independent practices that also work with broker-dealers, said they are very likely to shift cash into index-based ETFs, the most of any product type, the survey found.
The next-most popular choice for both groups was active ETFs, with 13% of each RIAs and hybrid RIAs saying they were very likely to put their cash in such products , the survey found.
Just 7% of RIAs and hybrid RIAs said the same about passive mutual funds, according to ISS' report, which is based on eight proprietary surveys conducted across 8,000 advisors.
Passive ETFs have long been a strong preference among RIAs, but active ETFs have picked up fans in recent years, said Dennis Gallant, an associate director at ISS Market Intelligence.
"Historically [independent broker-dealer] reps, in the pure sense, not those that are hybrids, have been more active management-oriented: heavier mutual fund and ETF use than the other channels," he said. "What we're finding is that [RIA] interest isn't just moving more to passive but also [to] active ETFs."
Morningstar Direct data show the number of actively managed equity mutual funds with upward of 5% positions in cash fell from 156 products at mid-year 2023 to 87 as of year-end, according to Ignites.
Stock pickers for these funds pared their money fund holdings by about 17% during the second half of 2023 to an estimated $47 billion as of Dec. 31 — the lowest level since 2016, according to Ignites' analysis.
The $121.9 billion Fidelity Contrafund, for example, recorded the largest reduction in cash parked in money funds, the data shows.
The product's holdings in the Fidelity Cash Central Fund dropped by $1.1 billion between June 30 and year-end to $2.6 billion, filings show.
Fidelity didn't respond to a request for comment.
"Timing is everything, of course," said Jeff Tjornehoj, senior director of fund insights at Broadridge told Ignites. Increased cash reserves make sense in down markets while the opposite holds true if a manager senses an upswing.
"When your primary strategy is expected to outperform cash, holding something because it has a 4% to 5% annual yield doesn't make sense," Tjornehoj said.
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