Big investors refuse to give up on cash

Recent stock market rallies have yet to shake loose the estimated $4 trillion in cash sitting on the sidelines, underscoring the fact that the name of the game for big money managers isn’t generating a return on capital but assuring a return of capital.

Demonstrating just how guarded the investment community has become, the amount of money sitting in various cash strategies is roughly equal to the total market capitalization of the Wilshire 5000 Index. Indeed, much of that cash is locked up in Treasury bonds.

The current yield on a 10-year Treasury note is 2.8% if held to maturity. Two-year notes are yielding 0.96%, and six-month notes are yielding 0.4%.

Some market watchers say securities that don’t carry a government guarantee are almost radioactive.

“In this environment, nothing that is going to give you an incremental return on your cash is worth the risk,” said Edward A.H. Siedle, president of Benchmark Financial Services Inc., an Ocean Ridge, Fla.-based pension consulting firm.

“The risk-reward scenario is not favorable right now, and a half-percent return versus another Lehman Brothers-like loss is not worth it,” Mr. Siedle said in a reference to New York-based Lehman Brothers Holdings Inc.’s spectacular implosion last year. “There just isn’t anything particularly smart that an institution can do right now other than insist on a government guarantee.”

At this point in the market cycle, nobody is making apologies for building up huge cash positions.

NEED FOR LIQUIDITY

“There’s a greater need for liquidity in this market, and I think pension funds are sitting on a ton of cash right now,” said Jill King, a senior portfolio manager with Horizon Cash Management LLC, a Chicago-based firm that manages $2.2 billion worth of cash positions for alternative strategies, including hedge funds and private-equity firms.

A report last week showed that institutional hedge fund investors are now holding as much as $300 billion in cash outside of the $1.2 trillion hedge fund industry.

“Right now, we’re dealing with some of the great challenges of low-yield investing,” said Craig Columbus, president of Advanced Equities Asset Management, a Scottsdale, Ariz.-based firm with $450 million under management.

Mr. Columbus has cash weightings in client accounts that range from 6% to 20%.

While he has started gingerly moving back into the fixed-income and equity markets over the past month, his cash remains mostly in Treasury money market accounts.

“There’s lots of concern from a credit quality perspective surrounding [non-Treasury] prime money market funds,” he said.

The breaking of the buck last year by the $63 billion Reserve Primary money market fund, run by Reserve Management Co. Inc. in New York, did not help bolster investor confidence.

“People have gotten very conservative when it comes to cash, and the Reserve Fund gave a bad blemish to any money market fund not associated with a financial institution with a lot of capital,” said Bill Quinn, chairman of American Beacon Advisors, a Fort Worth, Texas-based firm with $40 billion under management.

“We have 5% in a combination of government and prime money market funds,” he added. “We clearly look at what the prime funds are investing in and who is standing behind it.”

Despite recent efforts by the Department of the Treasury and the Federal Reserve to reignite the economy by loosening the credit markets, the cash management space is still viewed by some as a minefield.

“We thought it was a no-brainer decision to move our clients’ money out of prime money market funds two years ago and into Treasury money market funds,” said John Nowicki, president of LCM Capital Management Inc.

The Chicago-based firm, which has $75 million under advisement, has increased its allocation to cash over the past year to 15%, from 2%.

“Most people don’t realize that a money market fund can lose your money or even that it has an expense ratio,” Mr. Nowicki said. “We moved our clients to Treasury money market funds because we know there is too much gobbledy-gook garbage in all the other money market funds.”

TOO MUCH DEMAND

There has been such an appetite for Treasury money market funds that some firms have started limiting access to their government-guaranteed money market funds.

Among the companies that have already stopped accepting money from new investors into their Treasury funds are Charles Schwab & Co. Inc., Fidelity Investments, The Goldman Sachs Group Inc. and The Vanguard Group Inc.

For investors ready to go back into the markets, there are some new signs of life, including a record $68 billion worth of investment-grade-corporate-debt issuance in February.

This compares with $35 billion issued in February 2008.

“The corporate-debt issues is an indication that we’re heading in the right direction,” Ms. King said. “But I still don’t know what will come from this.”

Mr. Columbus believes that the Fed is trying to drive Treasury yields down to the point where investors will have no choice but to take on more risk.

The problem with that strategy, he added, is the risk that investors will feel compelled to save even more money to compensate for the lower yields.

“Government officials are battling against the forces of investor psychology and risk aversion,” Mr. Columbus said. “This has not been your garden-variety bear market, because for most people, this is their first exposure to complete system failure.”

E-mail Jeff Benjamin at [email protected].