Cash may be king for investors scared about sky-high stock prices and future market corrections

Key Points
  • Some money managers are recommending clients to increase their cash holdings in their portfolios.
  • Holding between 5 and 10 percent cash provides downside protection and the ability to buy into falling markets.
  • However, there still seems to be support to the momentum sending markets higher.
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Is cash really king? With equity markets and valuations near long-time highs, investors may need to consider whether to stick with the asset class or instead hold more cash to capitalize on any future corrections, experts tell CNBC.

One expert advocating for cash is Charles Newsome, divisional director at Investec Wealth. He is recommending clients to increase their cash holdings in their portfolios just a little bit, he told CNBC last week.

"It is increasingly difficult to find value across the market in equities currently and having a bit of cash as an option against a market correction must be a good idea, so moving towards 5 to 10 percent cash," he said.

He added that more aggressive investors may want to hold a 20 percent share of cash in their portfolio.

The difficulty in finding value is because many stock markets are at or near record levels, or are trading at expensive price to earnings ratios (the company's stock price compared to its earnings per share), which can indicate if a stock is overpriced.

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The U.S. Nasdaq composite is routinely setting fresh record highs; year-to-date it is up 21.71 percent and currently has a high price to earnings ratio of 25.58. This means someone would need to invest $25.58 to receive $1 of earnings.

Newsome's stance is similar to other asset managers who are concerned about the market and seek more protection and cash positions. Published last month, the Bank of America Merrill Lynch July Fund Manager Survey polled 207 asset managers with $586 billion under management and found that while the average cash balance had dipped to 4.9 percent from 5 percent last month, the 10-year average remains above 4.5 percent.

"Risk appetite remains equivocal with global cash balances still high at 4.9 percent despite clear inflection point lower in global growth/earnings per share estimates," the survey said.

The survey found 45 percent of investors had a bearish view on markets, with a crash in bond markets or a central bank mistake being their biggest fears.

Nathan Sweeney, senior investment manager at Architas, also recommended holding between 5 and 10 percent cash, in order to provide downside protection and the ability to buy into falling markets.

"We believe it to be prudent to hold more elevated cash levels in portfolios to take advantage of the opportunities as they arise. You also tend to get a bit more volatility during the summer months, which is another reason to keep some powder dry," he told CNBC via email.

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Sweeney's reasoning is that central banks are moving towards taking a different approach and may soon announce plans to reduce their balance sheets.

"We expect the uber low volatility that has been trending lower and lower to reverse. Markets will no longer be automatically supported by monetary stimulus and focus will switch to the fundamentals."

He added that his firm remains "underweight" on equities and believe there is a risk they will disappoint, especially in the U.S. where the firm believes the stock market looks expensive.

What's the counterargument?

Ayesha Akbar, multi-asset portfolio manager at Fidelity International, says her team would not advocate having too much money in cash at the moment.

"We still think this is an environment that favors equities," she told CNBC during a phone interview last week.

"At the moment we have an environment of synchronized global growth. It is looking pretty good compared to what we've seen in recent years. Inflation remains relatively benign. In our view, that combination is very good for risk assets and equities will definitely be a part of that."

Akbar added that there still seems to be support to the momentum sending markets higher and higher. And although equity valuations are getting expensive, this move has been segmented: Some sectors, such as tech, have eye-wateringly high valuations and look stretched, while other haven't performed quite so well and look good.

"So yes, it's time to reinvest, but probably not time to be adding to cash," she said.

Where should I invest?

Akbar said they are looking for pockets of value within equity markets, so are rotating out of sectors such as technology and into areas which have underperformed, as the current environment of global growth will provide these areas with support. They are considering areas such as energy and basic materials.

Newsome also suggested some sectors which investors could consider, such as retail.

"If you start looking for the really oversold ideas or the things that markets have fallen out of love with you can see some value. Retail and things like that, the market really viscerally hates them at the moment and I'm beginning to think it may be worthwhile starting to look in this area," he said.

Sweeney suggested diversifying away from equities into alternative income ideas, such as environmental assets, aircraft leasing and catastrophe bonds.

"These underlying investments have little to no link to equity markets and behave very differently so if we see equity markets sell off it is unlikely we will see the likes of catastrophe bonds, which are weather related, being effected," he said.

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