Cash Gets a Bigger Role for Institutions, NextGen Honorees Say

They describe how higher rates have elevated the once-ignored asset class into a vital position.

Reported by Larry Light

Art by Jam Dong


Cash, courtesy of the Federal Reserve, is no longer an afterthought among institutional investors. When the Fed raised its benchmark rate to more than 5.0%, from near zero, cash became the Cinderella of the financial world. That famous putdown by hedge fund honcho Ray Dalio—“cash is trash”—is now a relic.

For state and local pensions, cash as of 2022 stood at 2.1% of assets, a level that has remained fairly constant in the 21st century owing to low interest rates. The current trend of higher rates has changed the way cash is regarded, according to CIO’s NextGen honorees in responding to questions we posed to them.

“For the first time in more than a decade, I think cash should be treated as an extremely competitive asset class,” wrote Jose “J.P.” Hipolito, director of equities and commodities at Dow Chemical Co.  “It is going to be offering compelling real rates yield with zero duration or drawdown risk as central banks execute the ‘higher for longer’ monetary policy glide path to curb inflation.”

Hipolito noted how anomalous it is for stocks to be less attractive than other asset classes, with the S&P 500’s expected earnings yield expected to be 4.9% next year and the federal funds rate 5.5%.

In that spirit, another honoree, John Fujiwara, head of strategy at the Iowa Public Employees’ Retirement System, observed that “cash has been long viewed as a drag on portfolio returns.” Higher rates, however, mean that cash now must be considered a “tool for any tactical asset allocation decision.” In fact, he added, “it is not too far-fetched to imagine a quarter or two in which cash outperforms both stocks and bonds.”

Adjusting to this new climate offers great opportunity. Due to the higher rates, a smart move is to maintain “liquidity in relatively safe cash and short-duration, investment-grade fixed income,” according to honoree Steven Kaell, a managing director at Memorial Sloan Kettering Cancer Center. In his estimation, these liquid assets are useful “to mitigate drawdown risk and provide flexibility to lean into equity risk when investors panic.”  

Life is so much easier with the security of a sizable amount of cash. Consider the San Bernardino County Employees’ Retirement Association, which has 6% of its assets in cash, triple the average of U.S. public pension plans. This has its benefits. Amit Thanki, a senior investment officer at the California county plan, described how too often “sophisticated institutional investors find themselves in a liquidity crunch or out of compliance with asset allocation policies.” They have no choice other than to sell assets at a discount. “The cure is unnecessary,” he declared, with the proper amount of cash.

Asset allocation is an ongoing necessity for a portfolio, and there is a new role in the mix for cash. Customarily, cash generated by investments is plowed back into buying more stocks or bonds.

These days, though, cash throws off good returns, so it need not be recycled into other assets, by the reckoning of Brandon Tasco, a manager of real assets at the UAW Retiree Medical Benefits Trust: It might make sense to hold more cash distributed from current investments versus reallocating due to current cash returns.”

Further, the trend toward alternative assets means cash is more important than ever, argued Bryan Moore, a managing director at the South Carolina Retirement System. “Cash has a lot of utility today, especially as institutional investor portfolios are overweight illiquid asset classes” such as private equity and property, he wrote.

How far cash yields have risen is a source of satisfaction for the honorees. Cash and cash-like short-term Treasury bonds, Moore stated are, “compelling … with yields providing a return commensurate with what most institutional investors were happy to earn from high-yield bonds three to five years ago.”

As a result of all these considerations, many expect institutions’ cash stashes to swell in the near future. Corporate America can serve as a template for amassing cash, particularly Wall Street firms such as Goldman Sachs (holding $271 billion, more than twice its market cap) and tech titans like Google-parent Alphabet ($118 billion, or 7% of its much higher market value of $1.68 trillion).

Sure, pensions, endowments and foundations have different imperatives than businesses, but the flexibility that cash brings is prized by both profit-based and nonprofit entities. As San Bernadino’s Thanki put it, a robust cash account “allows institutional portfolios to be nimble at times of market stress by investing in better-valued assets” and meeting funding commitments.

 

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