Should I be worried about the % of Cash allocation?

Reue

Looking at my company pension scheme today at the fund allocations and I've noticed that there seems to be a very high cash allocation for this fund which is the companys 'default' fund for those joining the scheme and decades away from retirement. I was wondering if this cash allocation seems way to high to you guys?

Fund breakdown:

BlackRock (50:50) Global Equity Index Fund 40.4%
GMO Global Real Return (UCITS) Feeder Fund 24.9%
Standard Life Global Absolute Return Strategies Fund 24.2%
BlackRock Emerging Markets Index Fund 10.5%

Whats concerning is the allocations within the middle 2 funds:

GMO Global Real Return (UCITS) Feeder Fund
Cash 32.7%

Standard Life Global Absolute Return Strategies Fund
Cash 47.4%

jamesd

Given what they do I'm not concerned about the current level of cash in those two funds.

Today being in vested in that sort of mixture seems quite sensible. That would change after major stock market drops when a switch into more equity investments rather than absolute return would probably be a good move.

Those funds are there to reduce the potential to scare people out of the pension with a big drop in value during a big equity market drop of say 40%. They would be expected to cut the overall drop to more like 20-30%.

dunstonh

The objectives of absolute return funds could see large holdings of cash at any one time. Absolute return funds are not about getting the best return. They aim to get a positive return (or at least minimise loses). Although there are some high risk absolute funds which does seem to question what why they call themselves that rather than flexible investment.

Reue

Thank you both. I suppose the next question is whether I should consider switching to something more invested in equities given the long time span until retirement age. I was under the impression switching to large cash holdings would only occur once life-styling kicked in.

bowlhead99

The cash holding is misleading because absolute return funds can invest in some pretty complex ways - they are not straightforward "long only" funds because they are not investing to get a return correlated heavily with the return of bonds and equities, so they don't have their money spent on bonds and equities.

So for example GARS might decide to invest in a "relative value strategy" of short term investment grade debt versus long term index linked bonds. Or Consumer Defensive equities vs Raw Materials equities. Or Swiss Franc vs US Dollar.

In doing so they might have a contract to be, for example, "long" one type of equity and "short" another, which gives you net nil invested in equities when you do a simple pie chart of your equities vs bonds vs property vs cash, and large amounts of cash, at least on paper, but you are still exposed to the return from your activity - a position that can give you gains (adding to your equities or cash) or losses (consuming your cash, so you need cash in the bank).

Similarly a relative value currency play may cost you a small amount of money to buy the option or other derivative contract, but lead to potential growth of your overall asset value, while needing your own cash in the bank to use as collateral for the deal because you don't want to have to borrow money to support your positions because that would be even higher risk.

So, money may be hanging around on the balance sheet of the fund, but it is not that it is dead money with no expectation of a return whatsoever- they may have 20 different strategies going on at once. And so it's not the same as a fund manager who is literally waiting around in cash doing nothing waiting for more bargains on the equities markets.

GARS as an example has not delivered massive returns in recent periods while equities and bonds all went on a stonking run - but if you look at its historic record going back a decade or so, you will see decent gains with low volatility despite movements all over the place on the mainstream debt and equities markets.

jamesd

Reue wrote: »

I suppose the next question is whether I should consider switching to something more invested in equities given the long time span until retirement age.

Today I'd say the best answer to that question is likely to be no, and I've reduced my own equity holdings from close to 100% during most of the years since early 2009. The reason is that many popular markets are at quite high prices so there's significant drop risk and lower expected future returns on them. Notably the US markets.

This doesn't apply to all markets so a potential approach might be instead to take more detailed control of where money is invested.

In the short term the US does look a good place to be but that's short term market timing rather than longer term investing.

Unless you do want to get a lot more active I suggest that you wait for the next big US market drop before going to a larger long equity component. You're right in principle to have a high equity percentage, it's just not the best of time to be doing it with a global fund.

Malthusian

Notwithstanding the above explanations of the apparently high cash position, 48% is still an extremely high allocation to absolute return funds.

As Bowlhead says being long £50 of one share and short £50 of one share may give you a nil equity position on paper, but still has very different risk and reward characteristics compared to cash.

However in the long term, equities (held long, obviously) should be expected to provide a positive real return, assuming you have diversified enough to get rid of specific risk as best you can. For the same reason, short-selling equities should be expected to provide a negative real return. So if you had £5,000 long in a diversified portfolio of equities and sold £5,000 short of a diversified portfolio of equities, then not only would it look like cash but it would behave like cash, i.e. it would return pretty much nil.

Of course an absolute return fund is absolutely not going to short-sell a diversified portfolio of equities - the idea is that the fund manager through his extreme cleverness has identified which shares are going to go down (and got there before the market has) and therefore his alpha will produce a positive return.

But it is perfectly possible that the shares the fund manager has bought long go down and the shares he has sold short go up. Absolute funds sell themselves as being able to show positive returns in all market conditions but that also makes them one of few investments that can lose you money in all market conditions, including when stockmarkets are going up.

Also remember that when you sell short, losses can exceed deposits, as the spread-betting adverts say.

To invest 48% of your pension in this way requires a lot of faith in the alphaness of the two fund managers.

jamesd

One of my work pensions did a switch to using a lot of absolute return in 2009 after a lot of employees had become unsettled. Makes some sense given the challenges of encouraging pension use when most employees won't have much knowledge of what normal ups and downs are and can be scared out of the pension.

Malthusian

In 2009? !!!!!!. That's lawsuit territory. Switching into absolute return funds at the very bottom of the credit crunch crash could have cost the employees half the growth they would have received as markets recovered. (Or less, or more, obviously it depends on the exact funds.) The trustees must be hoping the employees stay ignorant of how their pensions work.

Replacing conventional boring correlated stockmarket investments with absolute return funds merely replaces normal ups and downs with abnormal ups and downs.

dunstonh

I am surprised the pension provider would do that. It would require discretionary investment management permissions and none of the providers have that automatically without permission.

jamesd

I don't recall whether it was for new money only or existing money as well, in part because I'd already switched out of the default. There was a significant consultation time and plenty of opportunity not to be part of the change. Just happened that the ending of that came close to the market bottom, though the start was after the initial drops in early 2008.

Those trustees no longer have to hope so much since the pension is now in a section 32 plan and the company itself taken over. Something like 75% of all members of the SL GPP in the new business don't use the SL default fund and about 90% of all employees were enrolled even before auto-enrolment at an average combined contribution rate of 11% of pay.

Personally I cut my pay back to minimum wage by salary sacrifice and went for 100% long equities after those early 2008 drops. Worked out well for me. But I'm not a typical employee.