March 2020 Newsletter An existential question – When to go to Cash

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I believe that an advisor’s job doesn’t end with just provide information on what to buy and get out of the way. This while helpful still leaves a gap for the investor. For the clients of Portfolio Yoga Advisory, I try to write my thoughts on the happenings of the market and how to go about thinking about it from the larger perspective / bigger picture. One such letter I write is the monthly letter which tries to tackle a subject that is generally of interest from the investors point of view. This is the letter for March 2021.

Since April, Nifty has had just 3 months where it ended in negative territory and these too were shallow with no month losing more than 3%. The only other time we had 3 or fewer negative months over the last 12 months and max loss in any month being lower than 3% was at the peak of the Harshad Mehta bull run. 

With markets seemingly disconnected from the economy, One of the questions I am asked the most is – when will you go into Cash. The very question though to me exposes a bias in the assumption that a portfolio that is constructed based on a factor called Momentum is somehow way different from portfolio’s constructed using other factors such as Quality or Value (Growth is not a factor). An advisory that is based on any other factor generally is not asked such a question even though no portfolio is immune to downside risks when the market as a whole tends to be bearish.

In the past, I have had several discussions on Twitter with respect to a question as to whether an equity fund should go into Cash or not. An equity fund I liked during those days (and continue to like even today) has moved multiple times in the past to cash when they felt that the market offered no opportunities in terms of good stocks at a fair price. 

Most funds though try to be invested all the time. This is not a bug but a feature since the thought process here is that the fund manager has no clue on the exposure of the client and he is just ensuring that the clients exposure to equity is 100% invested in equities. It’s either the Investor if he is investing directly or his advisor who needs to decide how much cash to hold or how much debt investments to have in the portfolio and one that is based on the risk profile of the client.

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Value based funds generally go into Cash when the markets are from the fund managers point of view relatively very expensive. This again is not based on the risk profile of the client but the inability of the fund manager to find decent stocks and ones that are trading cheap as well. This bodes well for them when the markets turn around and they are able to utilize the opportunity to invest the cash back into the market. Of course, this isn’t as simple as we assume for markets can remain irrational for long while investors who have multiple other choices may or maynot be willing to bear the pain of opportunity costs that they are seen to be bearing. 

Momentum on the other hand goes into Cash when the market has no Momentum. But this is not as often as people assume. Take a look at the chart below. 

The Y axis represents the range of Stocks with positive momentum and the bars represent the percentage of times we were there. So for example, of the 4000+ trading dates considered, we spent around 4% at the lowest bracket (approximately 160 instances). Of those 160, just 15 comprised the year 2020 (almost every day between late March to mid April). Rest were all during the 2008 / 2009 financial crisis.

But markets are volatile and hence additional rules have been devised to try and keep out of the market. One such rule is to not add to the portfolio but take only the exits when the broader index dips below the 200 day moving average. While the rule itself is simple, this can lead to more complications than necessary since 200 day is broken quite a lot. Since 2005, Nifty has broken below the 200 day EMA 63 times (or on an average 4 times a year). To reduce whips, an envelope could be introduced though that too gets whipped and the whips are generally most expensive vs the whips for just a simple moving average. As a wise man once said, there is no such thing as a free lunch.

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A secondary way would be to look out for trend breakdowns in the breadth index. For instance, historically whenever the percentage of stocks that are above their 200 EMA drops below the 20 barrier, it’s better to exit the market and wait for the crossover above 60 to reenter. 

The logic here is simple – when there is no trend available and even if there are some stocks that are trending, instead of trying to chase a mirage, it’s better to wait out until the broader trend re-establishes once again. 

The last time it had a sell signal was in June 2018 and the reentry came back only in August of 2020. Two problems here though – we don’t have enough signals to be sure that the strategy has its uses (a minimum of 30 trades would be required and there isn’t just that many trades) while on the other hand, it’s tough if not impossible from both a fund manager perspective as also a advisor’s perspective to be in cash for long periods of time.

Compared to using any other method this strategy seems to have limited whiplashes (but as with any trend following strategies, whips can never be eliminated). The average period of time it stays out comes to around one and a quarter year.

Bull markets are long yet can be volatile enough to make one wonder if the time is apt to move to cash. But cash is the alternative when the trend has truly broken down. This strategy for instance did not move to Cash in the depths of March 2020 but was in cash way before. This could be more of a coincidence though it does show that sometimes bad things happen when stocks aren’t at their best.

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Dual Momentum is another way though because of the lagging nature of simple trend following systems, it can be delayed on both ends not to mention the dreaded whips.

A method that seems to add value especially with respect to Momentum Portfolios is to cut exposure when there is high volatility (implied) as well as deep cuts in the equity curve of the portfolio. This again isn’t foolproof but has in the past tended to provide an exit before the deep cuts in the markets arrive. 

Don’t time the markets but be invested, say the experts and they are right. Timing can be risky and since markets always go up for if not growth, there will always be enough inflation out here in India and the longer your holding period, the higher the probability of ending in positive territory (even though if adjusted for inflation we may have gone nowhere for years. For instance, in dollar terms Sensex is up just 26% from its peak of 2008 – almost everything of it coming since November of 2020).

But markets are volatile and our behavior is finally the conjunction of a vast number of forces, many of which we may have no control. Human behavior can be modified but never changed. In that sense, it’s better to be safe than sorry and timing the markets can help a lot.   

This financial year should be more of a consolidation of the gains we have made in the last financial year but if the volatility becomes too high, rest be assured that we will be agile in ensuing that the boat doesn’t sink with the rest of the caravan.



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Prashanth Krish

Prashanth Krish

Prashanth is a Chartered Market Technician who believes in the Systematic Momentum Investing strategy. He runs his own portfolio advisory firm - Portfolio Yoga.
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