A number of fund managers have voiced concerns that a correction in global equity markets is just around the corner due to lofty valuations and increasingly bullish investor sentiment.While some of these have tried to mitigate risk by upping their exposure to undervalued areas of the market, others have decided to sit on large amounts of cash instead of putting money to work in the stock market.
For example, there are a number of funds in the UK sectors – such as GAM UK Diversified, Investec UK Smaller Companies and SJP Equity Income – that have more than 15 per cent of their portfolio in the money market.
Evan-Cook says he will avoid fund managers that keep high levels of cash if they are doing it because they think a market correction is imminent.
“Generally speaking, as a starting point, we like to have fund managers staying fully invested and leave the rest up to us. However, it depends how they are doing it," Evan-Cook said.
"What we don't like people doing is having a big cash position based on a macro call and we don’t like someone saying, 'oh we are a bit scared about this so I am going to have 20 per cent in cash'. We just don’t like that and we avoid the managers who do it.”
“We can do that ourselves, and you are just as likely to get that wrong as you are right. Once you are behind that curve in terms of that top-down macro call, then it is extremely hard to catch up,” he added.
Evan-Cook runs a number of multi-asset portfolios at Premier including its five crown-rated Distribution fund, which has been a top-quartile performer in the IMA Mixed Investment 20%-60% Shares sector over one, three and five years.
Performance of fund vs sector over 5yrs
Source: FE Analytics
While the manager was unwilling to name names, he says that one of the prime examples of this came in 2011 and 2012.
He admits that although there were a lot of risks facing investors at that time, such as China’s slowdown and the possible break-up of the eurozone, a number of funds were too defensive with their cash weighting as the market bounced back.
Performance of index between Jan 2010 and Dec 2012
Source: FE Analytics
“Loads of fund managers got caught with too much cash and then waited for that pull-back that never came,” he said.
“Then all of a sudden you are thinking, 'do I stick it all back in now?' Once you do invest, inevitably you stick it all back in at the wrong time and the big sell-off does come.”
“Basically, it can be a pretty good way to end a fund management career.”
As a result, Evan-Cook says that if a manager were to have more than 20 per cent in cash then that would be when “the alarm bells start ringing”.
However, head of FE Research Rob Gleeson recently told FE Trustnet that, in certain circumstances, holding a significant to weighting to cash can be a very useful tool.
“It’s perfectly reasonable for a manager not to plough into the market for the sake of it,” he said.
“If you can’t find the opportunities, then it’s a perfectly valid strategy.”
“It’s far better to be sitting on cash and waiting for better opportunities than being in expensive stocks that have the potential to fall sharply. If you have a methodology that you believe in, then you should stick to it.”
Evan-Cook agrees with Gleeson to a certain extent, saying there are a number of managers that can be forgiven for not being fully invested as it is just part of their strategy.
“We have to find out the reason behind it, as some managers really are very valuation-focused," he said.
"We own JOHCM UK Opportunities, which is managed by John Wood. He has 20 per cent [in cash] and he is all about valuation.”
“It’s nice to have your defender, or your goalkeeper, who you know is going to be quite grumpy about valuation.”
“We accept his reasons for going into cash and we know that when the stock gets cheap again he will dip back in; he is not waiting for a macro event. However, if he was getting beyond that level, then that would be a concern,” he said.
Wood, who is an FE Alpha Manager, has managed the five crown-rated JOHCM UK Opportunities fund since its launch in November 2005.
According to FE Analytics, the £1.2bn fund is a top-quartile performer in the IMA UK All Companies sector over that time, and has beaten the FTSE All Share, with returns of 109.6 per cent.
However, Wood’s cash weighting has remained above 10 per cent over the last 12 months and this has contributed to the fact the fund sits in the third quartile over this time.
Performance of fund vs sector and index since Nov 2005
Source: FE Analytics
While Evan-Cook says that Wood can be forgiven for not being fully invested, if that cash weighting were to increase any further, then he would reconsider his exposure to the fund.
“I guess if he was going beyond that, then we would probably find ourselves in a situation where UK equities are so expensive that maybe we should be considering whether we actually want them ourselves.”
Gavin Haynes (pictured), managing director at Whitechurch Securities, says that a vast majority of fund managers will hold high amounts of cash on valuation grounds, not due to a macro call.However, he agrees with Evan-Cook that it is a genuine concern if managers aren’t invested because of the latter, as he says that history has proved that timing the market is an extremely difficult thing to do.
“I think if an equity manager were to hold more than 10 per cent in cash then that would be quite extreme, but then it all depends what their strategy is,” Haynes said.
“However, if you are choosing a fund for equity exposure, then you want it to be trying to beat the market, which is difficult to do if the manager is holding a lot of cash. Also, if you are paying equity fund charges over the long-run then you don’t want to have to be paying for a large proportion of it in cash,” he added.
