When in doubt -- go to cash. That's the strategy keeping many doubt-plagued investors on the fence waiting for clear signs the markets and economy are heading up. Even the big institutional investors are stocking up on cash. If you have a lot of cash in your portfolio and your mutual funds have a heavy weighting in cash, there might be a liquidity swamp forming that could use a little draining.
To find out just how deep you are in cash, and to get a glimpse of how the pros view the market, you first need to know the cash weightings in your mutual funds. They are sometimes posted on websites like globefund.com and fund company websites. In some cases they are either way out of date or not available to the public.
Some managers hold no cash, opting to remain fully invested on the premise unitholders are paying them to invest -- not hold -- cash. Others hold cash to avoid downturns and be ready to invest quickly when opportunities arise.
For example, the Mackenzie Cundill Global Balanced fund, managed by famed value investor Peter Cundill, lists a 45-per-cent weighting in cash as of Jan. 1. He invests about half the fund's $730-million in a broad spectrum of stocks in several sectors and countries. Roughly $350-million is at Mr. Cundill's discretion if he finds undervalued investments with long-term growth potential.
But the average retail investor is no Peter Cundill, according to Scotia Capital Inc.'s director of mutual funds Ian Filderman. "The danger of trying to time the market is getting it wrong," he says. "You need to make two right decisions: when to get in and when to get out." His point is: Cash positions in mutual funds sometimes change frequently, and some investors may prefer their own cash cushion regardless.
But how much is enough cash? The basic recommended cash weighting in a retail investment portfolio is 10 per cent, but the amount depends on the comfort level of the individual investor. Mr. Filderman says investors wanting to deploy excess cash into the market should cost average -- buying a security over time and spreading out the risk.
The biggest risk to being in pure cash is having its value diminish as the cost of living rises. So, the best place to keep cash without losing its safety and liquidity is in a product such as a money market fund.
Money market funds are fixed-income securities that mature in two years or less, such as T-bills or guaranteed investment certificates. The average Canadian money market fund returned just under 3 per cent last year -- slightly ahead of inflation. There are hundreds of money market funds available with very little difference between them, except management expense fees (MERs), which range from zero to 2.35 per cent. "It's one asset class where fees are most important," Mr. Filderman says. If a money market fund is underperforming its peers, the cause is most likely a high management fee.
If investors expect to be in cash for several months and hope for a higher return, there are several transitional funds. But there is a tradeoff: "The second you get out of cash you take on more risk and sacrifice liquidity." There's no guarantee the value of your initial investment will be higher at any given point after purchase -- as is the case with a money market fund.
Canadian short-term bond and mortgage funds: To eliminate currency risk it is suggested transitional funds be purchased in Canadian denominations. Short-term bond funds primarily invest in fixed-income securities that mature in five years or less. That includes higher-yielding government bonds, high-quality corporate bonds and mortgage-backed securities.
Over the past 20 years the average Canadian short-term bond and mortgage fund posted an annual return of 6.9 per cent. But, in 2006 the average fund grew 2.7 per cent -- highlighting the risk of having to liquidate quickly if a long-term investment opportunity arose.
Bond funds: There's a mix of long-term and short-term fixed-income securities in a bond fund -- including both government and corporate bonds. Portfolio managers trade the holdings on the bond market so there's a risk of capital loss, as well as the potential for greater returns.
The average Canadian bond fund returned an average 5 per cent annually for the past five years. The average foreign bond fund returned 2.2 per cent in the same period due to the relative strength of the Canadian dollar on foreign markets.
High-yield bond funds: High yield usually implies a higher risk of default by the issuer. These are mostly corporate bonds that must pay high yields in exchange for the increased risk. Over the past five years, the average high-yield bond fund returned 6.6 per cent annually.
Balanced funds: These funds try to strike a balance between fixed income and equities. The fixed-income portion helps offset the risk in the equity portion with the hope of producing strong, steady returns.
Over the past five years the average Canadian balanced fund grew 6.3 per cent annually, while the average global balanced fund returned 4.3 per cent.
Income dividend funds: This is likely as far as you'll want to go on the risk reward scale for a transitional fund. Income dividend funds invest in interest-bearing, dividend-paying or distribution-paying securities. The fund invests mostly in stocks and income trusts. Over the past five years the average income dividend fund grew only 4.3 per cent annually, but last year alone returned 9.9 per cent.
Dale Jackson is a producer at Report on Business Television.
Weighting in cash as of Jan. 1 in Peter Cundill's Mackenzie Cundill Global Balanced fund.
The basic recommended percentage cash weighting in a retail investment portfolio.
Return of average Canadian bond fund for the past five years.
Return of the average foreign bond fund for the past five years due to the relative strength of the Canadian dollar on foreign markets.
© 2007 The Globe and Mail. All rights reserved.
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