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The Benefit Of Having Cash As Dry Powder

I recently had the pleasure of travelling to Brisbane to discuss our upcoming ASX-quoted Montgomery Global Equities Fund (Managed Fund) (ASX: MOGL). As always, our adviser and broker clients had some great questions about MOGL, including: what’s the benefit of the significant cash holding?

For context, the Montgomery Global Fund (MGF), the unlisted version of MOGL, has held on average around 20 per cent of fund assets in cash over its 28-month life to date. Importantly, the cash weighting has not stopped MGF from outperforming its global equities benchmark – the MSCI World Net Total return in Australian dollars. One dollar invested in the fund is worth $1.30 at the end of October and a dollar invested in the benchmark would be worth $1.22. We therefore say that the benefit of the cash has been to reduce the risk associated with achieving these returns.

Moreover, readers and clients will know that we also view the cash holding (a touch over 21 per cent at the end of October) as a cushion to protect capital should the market turn down. For example, if the market index drops by 20 per cent, and the stocks in MGF also decline by 20 per cent, then MGF as a whole will only fall by 16 per cent. But there is another important benefit to holding cash that often goes untold: cash provides the dry powder to invest in stocks when they become cheaper after a pullback in stock prices that can also lead to outperformance.

Consider the following example of two hypothetical funds: the “Shut the Gate Fund” (or SGF) and the “Dry Powder Fund” (or DPF). Both funds can vary their stock and cash weightings. The difference is that SGF begins by being fully invested and sells stocks in response to a market fall (assume 20 per cent of the fund), whereas the DPF begins with some cash (assume 20 per cent of the fund) and deploys this cash when stocks pull back. Assume both funds begin with $100,000 in funds and their respective stock portfolios track market returns over the next 2 years, which happen to be down 20 per cent then up 30 per cent.

After the first year, the funds perform as shown below:

Screen Shot 2017-11-21 at 12.29.45 pm

Clearly, with a lower exposure to equities at a time when stocks declined, DPF outperformed SGF by $4,000. That’s the first benefit of cash on show. But now look what happens in year 2, after SGF sells down its stock portfolio in reaction to the losses taken in year 1 and its desire to reduce future exposure, and the DPF deploys capital into shares.

Screen Shot 2017-11-21 at 12.30.12 pm

By deploying dry powder and moving funds from cash to stocks at the beginning of year 2, DPF has captured a $25,000 gain and finishes with $109,000 in client funds. On the other hand, SGF only captured a $19,000 gain after allocating more of the fund to cash and therefore missing the upswing in share prices. DPF has outperformed by another $6,000 for total outperformance of $10,000 over the 2-year period (and positive absolute performance to boot!)

This simple example shows that the benefit of having cash as dry powder after stocks fall can potentially be even greater than the benefit of holding cash ahead of time to cushion any market downturns. MOGL (and MGF) clients can be assured that we are ready and able to deploy dry powder as and when the opportunities arise.

Invest in the Montgomery Global Equities Fund (Managed Fund) (ASX: MOGL) and receive or reinvest a minimum targeted yield of 4.5% p.a. To access the PDS and find out more, please visit the MOGL website.

View More Articles By The Montgomery Team

Roger Montgomery is the Chief Investment Officer of Montgomery Investment Management, montinvest.com, and author of blog.rogermontgomery.com.

Roger's step-by-step guide to valuing the best stocks and buying them for less than they're worth, Value.able, is available exclusively at rogermontgomery.com. Skaffold is an online stock-picking application that rates ASX-listed stocks from A1 to C5. Watch a demo of Skaffold at www.skaffold.com.



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