New York City Pensions Pursue Cash

(September 27, 2011) — Similar to recent proclamations by bond guru and DoubleLine Capital Jeffrey Gundlach, who has said he is favoring cash over nearly all investments, New York City’s pension funds have raised cash holdings.

The New York City schemes have upped their exposure to cash to about 8% on average after selling some high-yield bonds and stocks in the past three to six months.

“Usually we have zero” in cash, Larry Schloss, who oversees about $120 billion of retirement assets, said in an interview on Bloomberg Television. “There’s so much uncertainty now. Typically a pension fund would have their liquid assets in the stock market,” he said, adding that on a longer horizon, “equity markets are a great place to be.”

Gundlach asserted his ambitions to hoard cash last month, foreseeing 10-year Treasuries offering a buying opportunity if yields rise above 3.5%. “I want fear,” Gundlach, who previously co-managed the TCW Total Return Bond Fund, said in a telephone interview with Bloomberg. “I want to buy things when people are afraid of it, not when they think that it’s a gift being handed to them,” he said of speculative-grade bonds.

The investor preference for cash also follows recent assertions made by James Montier, a London-based portfolio manager with GMO. A flexible allocation allowing timely moves into cash gives an asset owner the best tail-risk protection, he asserted in a July paper. Institutional investors concerned about protection from black swan events often overlook the values of a flexible cash allocation, Montier argued. Other hedges like options/contingent claims and strategies that are negatively correlated with tail-risk simply do not provide the same level of protection.

Cash is “the oldest, easiest, and most underrated source of tail-risk protection,” claimed Montier in the paper, titled An Ode to the Joy of Cash. “If one is worried about systemic illiquidity events or drawdown risks, then what better way to help than keeping some dry powder in the form of cash—the most liquid of all assets.”

A flexible cash allocation provides the best tail-risk strategy because it minimizes what Montier called “Valuation Risk” and “Fundamental Risk.” Valuation risk is the risk connected with overvalued assets. According to Montier, cash is a much better investment than sticking with overvalued assets. “In our view it is better to hold cash and deal with the limited real erosion of capital caused by inflation, rather than hold overvalued assets and run the risk of the permanent impairment of capital.” With fundamental risk, or the risk of “write-downs to intrinsic value,” cash is a good hedge because it “is a more robust asset than bonds, inasmuch as it responds better under a wider range of outcomes.” Thus, he asserted that an allocation to cash can increase a portfolio’s resistance to varied fundamental risks.