Although investor confidence has improved, a majority of wealthy clients acknowledge that some of their assets are sitting on the sidelines. Frustrated with minuscule interest rates or with the fact that they failed to anticipate the stock market rally, many high-net-worth individuals concede that they have a substantial part of their holdings in cash.
For advisors, this can be a challenge. They understand why some clients are not making the best use of their resources. But they struggle to find alternative investments that will perform well and still allow their clients to sleep soundly at night. Some are making greater use of REITs, master limited partnerships, short-long investments and managed futures.
The cash hoarding dilemma shows up in 2013 U.S. Trust Insights on Wealth and Worth, an annual nationwide survey that measures the outlook of investors with over $3 million in investable assets. The survey reports a significant reversal in the past year of respondents' main goal. Last year, 58% said preservation was their main goal. This year, 60% were focusing on growth. Yet over half, 56%, had a substantial portion of their funds in cash, despite this new focus. The amount of cash held at banks is hovering around $1 trillion, a five-year high watermark, according to reports from the Federal Reserve.
What's the Problem?
"The mind-set has changed so dramatically to growth over preservation, [but] more than half of this group still has a lot of cash on the sidelines," says Chris Heil- mann, chief fiduciary executive at U.S. Trust, Bank of America Private Wealth Management. "Something doesn't compute."
The problem is that a number of investors, shell-shocked from the crisis, have become market timers, Heilmann says. Even as the market showed signs of improvement, weary investors made excuses for not moving in. Then, once stocks rose, they worried they were getting in at a peak.
Women and younger investors reported being the most growth-oriented, but also had the most cash sitting on the sidelines. Of the high-net-worth individuals in the study, 65% of the women and 69% of the Generation Y investors reported that cash represented a substantial part of their investments. Heilmann speculates that members of the younger generation are less confident because they have not lived through the historic cyclicality of the market.
"This really is the best case for working with a professional advisor," Heilmann says. "This is a client base that needs advice."
At Baird, some clients seeking advice have shown interest in investments that they may have never used before, such as real estate investment trusts and master limited partnerships. "We're seeing more hesitancy to go back into the same old things," says Tim Steffen, the firm's director of financial planning. "People want something different."
Those requests can be beneficial if they lead clients to a more balanced and diversified portfolio, Steffen says. While such investments would never completely replace a client's stock or bond positions, they do have a place now that clients and advisors are hunting for a level of performance or yield worth spending cash on.
"When a client comes looking for those things, we always talk about the risk-[versus]-reward tradeoff first," Steffen explains. "You want this because you think it will give you 'A,' but understand it may also give you 'B.' Are you willing to accept that and how does it fit into your portfolio?"
Raymond James advisor Van Pearcy, who is based in Midland, Texas, also sees a greater willingness among investors to consider more obscure products, but only when the options are effectively explained. "Clients are much more hesitant to just move and jump in with both feet," Pearcy says. "You've got to provide them with additional facts as to what types of systems are in place with the money manager to help provide some downside protection."
Pearcy's firm, which bills itself as one of the more conservative offices in the region, has found success with hesitant clients through alternative offerings like long-short investments and managed futures, which could constitute as much as 20% of a client's portfolio. He also uses the firm's software to stress-test a portfolio and show the client models of what would happen if the stock market dropped.
"If the market goes up, we may not capture as much, but if the market goes down, we do all right," Pearcy says. "[We] make sure they're aware of what the downside could potentially be."
A Long-Term Focus
Advisors at U.S. Trust are working to keep clients who have been hoarding cash centered on a long-term outlook and to help them understand the fundamentals of their investments. If a stock is at a 52-week high, for example, it does not necessarily mean clients should avoid purchasing it; they need to look at the fundamentals of the company and the industry first.
"It's really about looking at the underlying assets or asset classes," Heilmann says. "That's where I think of a lot of investors really do need advice."
Instead of timing the market, Heilmann believes, clients would be better off in the market, while paying attention to asset allocation and making sure they are well diversified. He points to the technology bubble of the late 1990s as an example of the need for an advisor to help guide clients through market cycles.
"What we saw then was a real flight to advice," he says. "Coming off the 2008, 2009 global economic issues that we faced, we're finding that there continues to be a flight to advice."
But what about the very rich investors who apparently have not sought out advice? A good portion of the 56% with excess cash probably consists of fixed-income investors, according to Mark Augusta, a senior vice president for investments who specializes almost exclusively in fixed income at Los Angeles-based Wedbush.
Disenchanted by low interest rates, a majority of Augusta's clients are waiting for what they believe will be an inevitable rise in rates. One client who has never had cash sitting in his account has been keeping a substantial amount uninvested for the past seven or eight months, he says.
"I have more clients who aren't doing anything," Augusta says. "Generally, they're very sophisticated people, and they believe that the Federal Reserve program of bond buying is going to come to an end. When it does, we're going to see a creep up in rates."
In the meantime, Augusta has been looking for options to recommend to fixed-income investors. In some cases, he has suggested shortening or laddering maturities. This might mean buying bonds maturing at 10 years instead of 30. "It's hedging your bet because you know that you're going to get your principal back in 10 years. Then you hopefully invest it at a higher rate than what you had the first time," he says.
But Augusta is not pressuring clients to move their funds allocated to fixed income out of cash. For some, it may make sense to hold onto cash, he says. Many have alternative income sources, are invested in equity markets through other advisors or can wait for interest rates to go up. It's a bet that these clients will be able to make enough later, once rates rise, to compensate for whatever yields they are missing now by sitting in cash, he notes.