Asset Managers Turn Bearish, Hoard Cash | Chief Investment Officer

Investors are stockpiling cash and exiting European and UK assets, according to a survey of asset managers.

The average cash balance among 160 global investors rose to 5.8% this month, according to Bank of America Merrill Lynch’s (BoAML) research. This was the highest level recorded by the survey since November 2001.

Managers are also buying protection against stock market falls at a record rate, BoAML reported, while taking up underweight positions in equities, especially in the Eurozone and the UK following the latter’s vote to leave the European Union (EU).

The survey reported participants’ first net underweight to the Eurozone in three years after a collapse in sentiment. In June, allocators had a net overweight to the region of 26%; by July this had fallen to a net 4% underweight.

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Asked about future central bank policy, 39% of respondents said they expected at least one major central bank to adopt a “helicopter money” strategy in the next 12 months, injecting cash directly into the economy rather than buying government bonds.

A net 44% of investors said global fiscal policy was “currently too restrictive”—a record level for BoAML’s survey.

Average cash balances, July 2016. Source: BoAML Managers’ average cash balance. Source: BoAML Global Fund Manager Survey.Reflecting the shift in sentiment, Columbia Threadneedle’s European CIO Mark Burgess this week stated his firm had pulled back on its favorable view of equities, which it had held for more than five years.

The post-referendum equity rally “feels somewhat unjustified and unsupported by the fundamentals,” Burgess said. “There are going to be a number of headwinds facing the UK economy as it detaches itself from the EU over the coming years, which will likely reduce economic activity in the UK and impact domestic profits.”

The impact of the US elections in November and a possible broader fallout from Brexit across the EU were also important concerns, Burgess added. “We are also mindful of the global debt burden and global overcapacity, and are particularly alert to the alarmingly high levels of non-performing loans in the Italian banking system, as well as China’s ongoing attempts to rebalance its economy.”

Combining multiple factor exposures has already been shown to deliver higher returns and diversification. But how investors combine those factors can also make a tangible difference in a long-only portfolio’s performance, according to researchers at AQR.

Rather than just “mixing” factors—building separate standalone portfolios for each style and then combining those portfolios at the desired factor weights—investors should “integrate” factor exposures, argued Shaun Fitzgibbons, Jacques Friedman, Lukasz Pomorski, and Laura Serban.

“The integrated approach is a much more effective way to harvest long-only style premia,” they wrote.

AQR smart beta portfolio construction Source: “Long-Only Style Investing: Don’t Just Mix, Integrate”An “integrated” portfolio differs from a “portfolio mix” in that assets are viewed through the lens of multiple factors at the same time. For example, instead of creating separate portfolios for value and momentum and combining the two, “integrated” investors would build just one portfolio of assets that has been filtered for both value and momentum.

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This way, the portfolio contains assets with “reasonably positive exposure to many styles rather than stocks with extreme positive exposure to one style that may simultaneously have extreme negative exposure to another style,” the authors explained.

For their study, Fitzgibbons, Friedman, Pomorski, and Serban constructed long-only multi-factor portfolios using both strategies. They found that integrated portfolios improved excess returns by 1% per year compared to mixed portfolios, while also increasing the information ratio by 40%. The more factors they combined, the more these benefits increased.

“Integrating styles in long-only portfolio construction has a first order effect on performance, generating benefits by avoiding stocks with offsetting style exposures and including stocks with balanced positive exposures,” they wrote.

While asset owners may prefer to hire different managers for different styles, or find it easier to monitor the performance of factors on an individual basis, the AQR researchers argued that such considerations “would need to be very important for investors to offset the direct performance benefits from integrating styles.”

“The integrated approach is likely to be meaningfully more attractive to investors,” they concluded.