A few months ago, we were frequently questioned about our asset allocations and the relatively high cash levels we were maintaining in our portfolio. Comparisons of returns were inevitable too.
In the face of these, we continued to think independently and stood true to our core values and philosophies.
As financial markets around the world were routed these past few weeks, our investors began to appreciate the value of the cash levels in our portfolio, especially the USD cash.
One of the reasons for the ongoing selloffs is the domino effect of panic redemptions from hedge funds and margin calls from the banks.
This stems from the mandates most mutual funds have to be almost fully invested. When panicked investors start to redeem, funds are forced to sell assets to meet redemptions.
Furthermore, funds that are leveraged are caught between redemptions by investors and the banks asking them to either shore up margins or risk a force-sell of their assets. In many cases, the latter happens.
In a private bank advisory portfolio, cash is often frowned upon. It is common practice for Relationship Managers to discourage their clients from maintaining cash in their accounts. In fact, banks might even offer loans to clients to finance even more investment.
Here’s a scenario for illustration; if a client has a million dollars to invest, their RM will likely recommend a portfolio of investment-grade or so-called “safe” bonds.
Because they are perceived as safe, a lower Loan-to-Value (LTV) ratio of say, 70% is assigned to the portfolio. This means the bank will be willing to lend the client 70% of his investment sum, or $700,000, to buy even more safe bonds.
Because the additional $700,000 are used to buy safe bonds, these $700,000 are further assigned 70% LTV, so the client can further borrow a further $490,000 to buy more safe bonds. This goes on, so the final investment sum can be as high as $2.2 million.
So now the client has a passive income in excess of $100,000 a year after the cost of borrowing. Everybody has a plan until you get hit.
COVID-19 was that hit. China locks down. Europe locks down. Financial markets go into turmoil. Everyone is selling. No one is buying.
With no bidders, those “safe” bonds are no longer safe. The banks are likely to reduce the LTV of that client’s portfolio from 70% to 30% or even 0%. This means the client now has to quickly inject over $1 million of cash into his portfolio or have his bonds force-sold at residual prices.
This is a margin call, something that has made wealthy people poor in crisis after crisis.
Is cash an asset? In times like these, cash is king.