A Flight to Cash?

A recent Merrill Lynch survey of fund managers reveals increasing pessimism about the prospects for global growth and company profits. Since 67% of managers believe that bonds are overpriced, are we about to see a migration from equities into - cash?

The following analsis may be useful in informing those contemplating a switch entirely out of equities and into money market investments.

This exercise looks at funds in the IMA's UT Money Market and UT Balanced Managed sectors. It spans the three years to date, taking in both a period of Bear market and the reviving conditions in 2004-5.

We can see that Prudential Maximum Income, the best performing Money Market fund, returned 11.80% over the three-years, while Credit Suisse Cash, the worst, only achieved 4.51% for its investors. It is not difficult to imagine Credit Suisse investors looking at this performance with dismay, and even the top fund in the sector could have been bested by some - fee-free - cash deposit accounts.

So what did they miss out on by not keeping some equity in the mix? The Balanced Managed sector leaps to mind as a promising area to explore for a combination of risk-free investments and exposure to equity markets. Here is the performance table from Analytics for the same period:

If you were unlucky enough to pick the worst fund in this sector, First State Balanced would have lost 5.76%; but the best performer, Capita Financial's Trojan, produced virtually two-and-a-half times the Money Market champion's return, at 28.62%.

Further, there are 17 more funds at the top of this sector which outperformed the best of the Money Market.

Note: CF Trojan, while insisting that it is a retail fund, carries a minimum initial investment of £25,000, or £7,000 if invested via a PEP or ISA. Clearly this is aimed at the bigger players, and so we'll also look at the runner-up in this group, the CF Midas Balanced Growth fund.

The Midas fund returned 26.33% over the three years, comfortably more than twice the Money Market's best, and its minimum initial investment is a more approachable £3,000. So far, so good, but see below for the less welcome aspects.

No funds in the Money Market group have a strong R-squared correlation with the sector to which they are benchmarked.

In these cases, most ratios will therefore have little relevance.

However, Volatility, a measure independent of the benchmark, is worth considering. In Money Market, predictably enough, Volatility is low, ranging from 0.10 to 1.05%.

CF Trojan also has a weak R-squared, and attempts to find a stronger correlation to another sector or index have proved fruitless. But, in addition to its winning performance, it also carries the lowest Volatility in its sector, at 5.77%. This is an unusual fund.

So, if CF Trojan's periodic returns can swing 5.77% either side of the overall 28.62%, the maximum downside would still have produced a positive 22.85% - nearly twice as much as the maximum upside for the Pru's money market offering of 12.41% (11.80 + Volatility 0.61).

The performance of the more accessible Midas Balanced Growth comes with the third highest Volatility in its sector, with swings of 14.2% either side of the median. Maximum downside, then, comes in a shade lower than the Money Market's best, at 12.13%. However, the R-squared correlation is robust here, and the excellent Jensen's Alpha and Information Ratio are indications of the managers' skill in adding value from their bets in the market.

It's not cheap in the Money Market sector. Pru's best performer will take an initial 2.5%, then a more reasonable 0.5% AMC. But the bottom ranking CS Cash - a MultiManager fund - will take an eye-watering 4.00% initial and 1.5% AMC while consistently scraping along at the bottom of the sector. The building society deposit account begins to look very tempting.

The Balanced Managed sector has its villains too, and, similarly, the worst-performing First State fund takes a 4.00% initial charge, then a 1.25% AMC. By contrast, the Trojan fund stands out once more - access to that level of performance costs nothing initially, and just 0.5% annually. But you'll need a lot of eggs if you're to put them in this basket.

For ordinary mortals, though, high charges are back again: the similar performance of the Midas fund will cost an initial 5%, then an AMC of 1.4%.

On holdings, there is little that stands out as significant, but there could be some mileage in looking at the sector weightings.

In Money Manager, the top fund is 95% invested in Floating Rate Notes, while the bottom one has 99% in cash. This begs the question: why would investors give up 4.00% of initial capital, then 1.5% per year, when they could walk down any High Street and open their own accounts for nothing?

In Balanced Managed, the worst performer looks far from balanced, with 77.2% invested in UK and International Equities, and only the remainder in cash and fixed interest. By contrast, the Trojan and Midas funds look much more widely diversified.

In both sectors high charges seem inevitable for the average investor, but pick the wrong fund and the manager will cheerily take that money while consistently delivering poor performance.

Even in mixed Bull/Bear market conditions, significant outperformance is still available if equity is retained in the asset mix. If you take on more risk in the process, the right fund will amply compensate for it.

In Balanced Managed, the best performance at the best price and lowest Volatility is not readily available to the more modest saver/investor. A similar return is achievable from the runner-up fund, but at the cost of higher charges and risk. Are the fat cats getting the cream while ordinary investors are just getting milked?

The worst that could happen with the best fund in each sector? Switch completely into cash and get a safe, capped return at half the level that could be achieved by a well diversified fund with equity in its asset mix. Or get it completely wrong with a good Balanced Managed fund, and you end up roughly no worse off (actually, with Miton, still better off) than you would've been with cash.