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Cash. Whether it’s 5% or 50% of the pie, every portfolio needs it. But where do you put it?

Not everyone agrees on how liquid an instrument has to be to count as cash. Andrew Johns, lead financial advisor in the Cash Management Group at Raymond James in Vancouver, says the standard industry definition is anything with a maturity of a year or less. Past that and you’re in the bond space.

James Price, director of Capital Markets Products at Richardson GMP in Toronto, takes a different view: anything past three months and it’s not liquid enough to be considered cash.

Cash management has three main components, says Johns:

  1. Principal protection: Cash should be parked at high-credit-quality institutions
  2. Liquidity: Clients should have easy access to funds (with no penalties)
  3. Yield: Advisors should find the best yield with no added risk and no loss of liquidity

High Interest Savings Accounts (HISAs), also called Investment Savings Accounts (ISAs), are the main cash vehicle for both Johns and Price. “A lot of people will tell you GICs are the place to go,” notes Price. “I don’t, because part of the appeal of cash is liquidity. You could buy cashable GICs, but […] there are alternatives that give you similar rates with easier mechanics.” He adds GICs are like fixed-income instruments.

ISAs and HISAs trade on FundServ like mutual funds. “They are always priced at $1, and underlying them there are deposits at the banks,” notes Price. “It looks like a money market fund, but the difference is that a money market fund is a mutual fund that purchases money market instruments like Treasury Bills and Bankers Acceptances. With an ISA, you hand over [money] to a bank, which puts it in a deposit; it’s almost like a chequing or savings account.”

Years ago, Price would park cash the way institutions do: in traditional money market instruments. With an ISA, he can now get clients about 1%, whereas a three-month T-Bill would get only 0.45%. “The banks have been very competitive in trying to attract client deposits over the past six or seven years, so they’ve offered very good rates on [ISAs].” Depending on the bank, they’re between 0.75% and about 1.5% (see “Straying from the Big 6”).

“[ISAs] check off most of my boxes,” adds Price. “They’re easy to buy and sell; they have one-day liquidity, which means you put your sell order in today and take your cash out tomorrow; and you get a yield.”

What to avoid

Price warns against a pitfall he’s sees all too often: “I have watched […] client after client stretch for yield [in the cash bucket] and get burned for it.”

About a year ago, when the appetite for risk among most clients was higher, many were using short-term, floating-rate-loan mutual funds and ETFs (which yielded around 3% to 5%) for cash exposure. “Their underlying investments are loans to companies that may be investment grade, but mostly aren’t. […] In my mind, those are just short- to zero-duration high-yield funds.”

Johns notes another temptation: market-linked GICs (a.k.a. Principal Protected Notes). They typically come in two-, three-, five- or seven-year terms and usually can’t be redeemed before maturity. They offer a minimum guaranteed return and cap any gains resulting from participation in the equity market. For example, the note may be linked to the TSX and stipulate a minimum return of 0.9% and a cap of 9% over three years. So, if the market goes up 26% over that three-year period, the client only gets 9% of it. Of course, if the market goes down 15%, the client still walks away with 0.3% a year. But there’s a catch: even though the investment’s linked to equity markets, the return stream is taxed as interest, not capital gains.

Johns only uses these instruments when the client does not need the money invested until the maturity date, and:

  • the client is a non-tax-paying entity, such as a municipality or charitable foundation that by law or mandate is not permitted to buy equities and does not pay tax; or
  • it’s a retail client who can place these instruments in a TFSA or RRSP, where the tax implications of the interest-based return stream are inconsequential.

As useful as these instruments may be for risk-averse clients, Johns would not use them in the cash allocation (given the lock-up period of over a year) or in a non-registered account (given their tax inefficiency). He adds that anything involving derivatives or special contracts, as is the case with equity-linked GICs, cannot be considered a cash instrument.

Be realistic

The instruments you use in clients’ cash allocations should vary based on when they’ll need the money and for what, says Andrew Johns, lead financial advisor in the Cash Management Group at Raymond James.

Say you have a client who’s spooked by the market and wants to go from 5% to 20% cash. Johns advises against parking the full amount in a one-year GIC. Instead, he would set up a GIC ladder.

Assume the 20% cash allocation is $120,000. Every two months, he would put $20,000 into a one-year GIC. The rest would sit in a HISA until it’s deployed in the ladder. Two months after the final $20,000 is deployed (one year after the first GIC’s purchased), the client will have $20,000 maturing every other month. By staggering GIC purchases, the client has funds available in the HISA should an immediate liquidity need arise. (See chart below.)

This won’t work for clients with greater short-term liquidity requirements, adds Johns. “If your client doesn’t know if [she’s] going to do a real estate transaction next week and [she] needs to have that money available at any given time, then keep it in a HISA.”

Cashable GICs are another option for clients taking a break from the market, adds Johns. “If [the client’s] out of the market and isn’t sure when [he] wants to get back in, but [is] pretty sure it won’t be in January, February or March, then buy a GIC that’s cashable any time after 90 days.”

Dean DiSpalatro is senior editor of Advisor Group.

Originally published in Advisor's Edge

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