Insight

Applied Philosophy - Following the cash within equities

Applied Philosophy - Following the cash within equities

Global equities have almost returned to their pre-pandemic peaks and “animal spirits” seem to have returned to the asset class. We feel this may be the right time to think about risk-mitigation strategies. However, traditional defensive strategies within equity markets either look expensive or are dominated by this year’s best performers. An alternative may be to find stocks with conservative financial management but that does not necessarily give us an edge even in market downturns. We think that our low volatility factor may still be the best available defensive strategy.

Recent headlines about the record highs reached by the US stock indices suggest to us that investors are confident that either the worst of the pandemic is over and the discovery of an effective vaccine or treatment is near, or that monetary and fiscal policy will remain supportive enough to keep markets afloat. Even if stock markets are not created equal and some are “more equal” than others, the general mood has been positive since the depths of the market crash in March. The MSCI World and All-Country World indices are close to their pre-pandemic peaks.

Although we do not foresee an imminent repeat of the market crash earlier this year (despite the recent tech-driven pull-back), we are slightly worried about the exuberance and FOMO (fear of missing out) attitude in equity markets. Therefore, we have been trying to find ways of hedging against potential risks within the asset class. The problem investors are facing is that risk mitigation strategies are either expensive (e.g.defensive sectors, such as healthcare or consumer staples) or they have rebalanced towards stocks and sectors that may be most at risk of downside (e.g. our low volatility factor index, which is dominated by technology and healthcare).

An alternative strategy may be to look for cash within equities, which has represented our idea of the ultimate defensive asset, because it keeps its value even when the economy slows down – at least in nominal terms – and has no volatility (in local currency). The COVID-19 crisis has highlighted the importance of this kind of resilience and of being able to cope with significantly lower or no revenues when many economic activities stop. Cash itself is, of course, a fixed income asset, so equity investors cannot really keep a large proportion of their portfolios in it. How can we access this kind of resilience in equity markets?

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