Understanding the interplay of volatility, liquidity… and safety
by Steve SelengutMr. Selengut is a private investor and a contributing editor to LIFE&Health Advisor. He is the author of the book ‘The Brainwashing of the American Investor: The book that Wall Street does not want you to read.’ He can be reached at [email protected]
An interesting debate; so let’s deal with it from an investment manager’s perspective.
I recently compared the two with respect to three MCIM (Market Cycle Investment Management) collective funds. These are individual security content funds, containing mostly Investment Grade Value Stock Index (IGVSI) companies and a broad variety of Income CEFs.
Would currently higher yielding (2%) Stable Value Funds (SVFs) be a viable alternative to currently stingy Money Market Funds (MMFs)?
MCIM managers view “cash” as a “temporary holding area” within the Equity Asset Allocation… derived from deposits, profits, dividends, and interest. During rallies, MMF balances are unusually large because few IGVSI companies are in buying range.
The fact that the income is minimal is more a political problem than an investment consideration. In the old days, when there were no MMFs, we held “zero return” cash. Why? Liquidity and safety. Liquidity is what a manager requires when “it” hits the fan and there are more lower priced IGVSI stocks to choose from.
As downturns progress, MMF cash is turned into new equity positions; the liquidity is our oxygen. SVFs can restrict large scale selling if they choose to, and redemption losses are actually possible. For a hands on investment manager, these are deal breakers… and here’s why.
The MCIM “equity bucket” objective is to be near fully invested before a correction ends and totally liquid in “Nirvana” conditions where every stock has been sold profitably and no qualifying IGVSI stocks are at reasonable prices.
Interplay of volatility, liquidity
The other consideration is the very idea of “stable value” as an objective… a concept that could only make the most insecure fiduciary more comfortable. Managers thrive on volatility, and their actions demand liquidity. Market values of all securities vary cyclically, and we view this as a good thing.
Equity bucket market value fluctuations are opportunities; income bucket market value fluctuations are even greater opportunities. Simply put, we buy equities for profit and income securities for income, and we make both volatility and market value fluctuation our VBFs.
The focus on short-term changes in market value is the greater (and not debated, ever) issue…. it’s all wrong. Benefit program focus needs to be on security selection quality and income generation, and although SVFs pay multiples of MMFs right now… where will they be when short term rates rise.
MMF cash is not part of the portfolio “income bucket”… what really should be concerning fiduciaries is the absence of 7%+ (currently) income Closed End Funds in their selection menus. CEFs produce multiples of both SVFs and MMFs.
Actually, at numbers between 6% and 9%, income CEFs provide multiples of target and income fund yields as well.
The very forces that will raise the yield of MMFs, will probably produce the lower priced IGVSI equity prices that MCIM managers need to put their cash stash back to work… SVFs won’t facilitate that effort. If rates rise rapidly, the SVF may not be quite as stable as fiduciaries would like it to be.
Providers of SVFs, target term funds, and ordinary income funds have one thing in common: they invest in income securities with an eye toward market value instead of a focus on income production.
Preparing the retiring client
If they were preparing an individual portfolio for a retiring client, one would hope that they would approach the problem with the opposite perspective.
I, for one, don’t obsess on the current market value of my portfolio of high quality, average 7.5% or so, monthly income, CEFs. If some of the prices rise, as they have been this year, I can sell them for profits (think about getting a year’s interest in advance to compound).
When prices fall, as they did for most of 2013, I can add to positions to increase yield while reducing cost basis per share… tough to do with individual issue bonds.
But the most important element of all, the portfolio income, is better than stable… it’s actually growing, and a perfect vehicle for benefit plans that are dedicated to the “retirement readiness” of participants.
For now, and again from an MCIM perspective: SVFs aren’t liquid enough for the equity bucket or high yielding enough for the income bucket. If we are trying to make defined contribution plans more like pension plans, we need to focus more on growing the income and less on short term changes in market value.
… and if we could get an income product that’s convertible to a personal income portfolio? Hmmmm.