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Experts say raising cash is part of a plan to have capital available when opportunities present themselves.Michael M Santiago/GettyImages/Getty Images

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With stock and bond markets undergoing a correction and falling into bear market territory, many advisors and investors are turning to cash in their portfolios.

A defensive positioning may also hold some appeal as the risk of economic recession grows. But is holding cash actually a good idea? And if so, what are some strategies for using it effectively?

“Over the long-term, holding too much cash generally acts as a drag on returns,” says Colin Stewart, chief executive officer and portfolio manager at JC Clark Ltd. in Toronto.

Due to inflation, the purchasing power of cash generally erodes over time, he notes. Therefore, it’s important to invest the cash into higher-returning investments like equities, bonds, preferred shares, and real estate.

Mr. Stewart says that over shorter-term periods, when uncertainty is high or asset valuations are at extremes, holding excess cash can be a good defensive strategy. He adds that the level of cash an investor should hold also depends on their risk tolerance, age, time horizon, and return objectives.

His firm is currently holding elevated cash levels of as much as 40 per cent within the equity funds it offers to clients due to what he calls the very high level of uncertainty in the market.

“We have had a higher than normal level of cash for most of the year and plan to stay cautious in the near-term,” he says.

He adds that inflation and rising interest rates have also made fixed income instruments unattractive and have, therefore, reduced the available tools for investors who wish to take a defensive posture.

When it comes to redeploying that cash, Mr. Stewart says his firm expects continued market and economic uncertainty in the near term and plans to be patient and deploy cash gradually.

“We are beginning to see interesting value opportunities in the markets and are doing our homework on several new investment ideas,” he says.

“We are seeing a number of excellent businesses trading at historically low valuation multiples and plan to utilize a portion of our cash in the coming months to make new investments.”

Taking an even bigger defensive stance

But some investment strategists are even more negative about the near-term investing outlook – and as a result, are looking at even larger cash positions.

“We noticed some of our market indicators breaking down about a year ago,” says Colin Cieszynski, chief market strategist at SIA Wealth Management Inc. in Calgary.

“We started adding cash in portfolios through the latter half of last year, and then accelerated the building up of cash in portfolios this year as market conditions deteriorated.”

Mr. Cieszynski says the shift to cash from equities has continued, and now SIA’s portfolios are holding no equities.

He says raising cash is part of a plan to have capital available when opportunities present themselves – and when SIA’s market indicators turn positive again, the firm will look to redeploy cash into the market.

That allocation will be based on SIA’s analysis of relative strength for sectors and individual stocks – “whatever is leading the market at that time.”

Meanwhile, Sadiq Adatia, chief investment officer at BMO Global Asset Management in Mississauga, has been advising portfolio managers at his firm to use cash instead of fixed income in their asset mix.

“In an environment of high inflation and central banks raising interest rates, that’s not always good for fixed income,” he says. “If you’re in cash, it’s much better. It’s not going to get you a huge return – but generally, cash and fixed income is the defensive part of your portfolio. So, that’s what cash will do a better job of.”

He hasn’t seen a significant change in that forecast since the beginning of the year, but notes there’s now less differential between the expected return between cash and fixed income.

When should you start buying equities?

Mr. Adatia says it’s not quite time for advisors and investors to begin redeploying cash back into the markets.

“Normally, when you hit bottom you have ‘panic selling’ – we haven’t seen that yet,” he says. “We need to see a bit of that happening to get closer to what we think the bottom is going to be.”

He says that, historically, when market indexes decline by 25 to 30 per cent from their peaks, it’s an opportune time to buy.

“We’d look to ‘dip our toes in’ at that time – and that’s when having cash positions can be useful,” he says. “Holding cash at this time is a very smart, prudent move, to be ready for those opportunities.”

However, not all investment managers are convinced it’s wise to be holding significant cash positions at this time.

John O’Connell, chief executive officer and portfolio manager at Davis Rea Ltd. in Toronto, says his firm generally only uses cash in a portfolio when deploying funds gradually, such as for a new client who may not want full, immediate exposure to the markets.

Mr. O’Connell says his firm has been urging some cash in portfolios over the past few months, but believes now is the time to put it to use.

“There may be more downside for stocks, but you can’t call the bottom,” he says. “Market timing, generally, doesn’t work.”

He tells clients not to worry about all the current negative factors, such as recession, rising interest rates, and inflation, as he believes those factors have now largely been priced into the market.

He notes there are many quality stocks at 20 to 40 per cent below where they were a year ago – and says now is the time to buy them.

“If you have any kind of reasonable timeline, you will be happy if you deploy cash now,” he says.

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