Investors hold cash for a number of different reasons, such as forshort-term liquidity needs, capital preservation, and when they’reconcerned about the impact that market volatility may have on theirportfolios. Depending on the reason, holding the bulk of their cashallocation in traditional cash instruments may not be the best option forinvestors.
A liquidity tiering strategy may help investors gauge how much cash theymay actually need in their portfolios based on their goals and objectives,and how much they should consider allocating to higher-returning shortduration strategies.
What this chart shows
Many investors hold more cash than they may need to meet their objectives.Shaped like a funnel, the liquidity tiering strategy below highlights theallocation building blocks and the approximate size of each depending ontheir goals and objectives. Tier 1, at the bottom, tends to be the smallestand is generally reserved for immediate cash needs and daily expenditures,while the larger Tier II can be used as a semi-permanent asset allocation;here, investors may consider actively managed short-term strategies toenhance their return potential versus traditional cash strategies. Finally,Tier III is often the largest of the three: Dedicated return drivers, likecore bond funds, can help investors seek to outpace inflation and preservepurchasing power over the long-term. Both Tier II and Tier III come with anescalating modest degree of additional risk versus traditional cashinvestments.
What it means for investors
Volatility can be worrisome, but rather than sitting on the side lines byover-allocating to cash, consider moving slightly up the risk-rewardspectrum with a tiered approach. Allocating to diversified,actively-managed short-term bond strategies in Tier II can help investorsenhance return potential while still maintaining an attractive liquidityprofile. And sticking with return drivers in Tier III, such as activelymanaged core bond strategies with a global opportunity set, can helpdiversify equity risk and potentially generate the returns needed forlonger-term spending needs.