What a (Cash) Drag!


At Nottingham, we take a core-satellite approach to portfolio management. This means we split client portfolios into two (equally important) parts. The core of the portfolio includes broad exposure to traditional asset classes based on a client’s risk tolerance, while the portfolio’s satellites are a collection of our best ideas. We attempt to enhance portfolio performance by using these satellite positions to invest in areas we find attractive, such as a certain sector or a particular country.

Financial markets are hugely dynamic and as we weed through all the noise, we come across a lot of “good” ideas. However, most of those never make it into client portfolios. That’s because we only invest in our most compelling ideas. Investment management can be tricky. Even when we like a particular investment, there is always the risk that it won’t work out. By sticking to only our best investment ideas, we control this risk by making sure that the odds of success are in our favor.


Sometimes we don’t have any “great” ideas and that’s okay. The professional money managers that claim to have an endless supply of brilliant ideas aren’t nearly as discerning and they’re typically the ones with a much lower success rate. Rather than include low conviction investments in client portfolios, we wait for the right opportunities to present themselves.

Although patience is a virtue, this can raise its own set of challenges. For example, what happens when we remove a satellite position from the portfolio and we don’t have a great idea for a replacement? How do we manage that situation? Sometimes, we take the proceeds and hold it in cash. This may be because we are getting close to making another investment and we want to have the cash on hand. This could also be to position the portfolio more defensively if we aren’t entirely constructive on the overall market.

But what happens when we already have enough cash in the portfolios to manage any future investment or liquidity need and we have a favorable view of the market? Cash equitization. Cash equitization is just a fancy finance term for the simple process of taking cash and investing it in broadly focused ETF’s to maintain market exposure. This prevents cash from weighing on overall portfolio returns when markets go up (so-called “cash drag”).

This is best illustrated by an example. This year, we owned a position in the Market Vectors Oil Services Trust (Ticker: OIH) in both our Global Equity and Global All-Asset strategies. The position was a fantastic performer for us, outpacing the S&P 500 by +11% on the year, which we subsequently captured by recently exiting the position.


Comfortable with current cash levels, we allocated the proceeds to the iShares S&P 500 ETF (Ticker: IVV) and the iShares MSCI ACWI ex-US ETF (Ticker: ACWX). We chose IVV and ACWX because they are low cost (0.07% and 0.34%), extremely liquid, and match up well with our domestic and international benchmarks. If markets move higher from here, the value of these positions will increase and we will eventually sell both IVV and ACWX to fund future high conviction investments.

So, the next time we exit a satellite position, I can’t tell you whether we will put the proceeds in cash, another satellite position, or an equity market proxy – that will depend on our current view of the market – but I can tell you that we will do the best thing to make sure we get the exact exposure we want for our clients.

Until Next Time,

Chris Hugar, CFA

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