Investors should initiate a systematic process to deploy cash into more productive assets, suggests the UBS wealth management research team.

Michael Crook and others in the UBS wealth management research team suggest that investors stay invested and balanced as part of their strategy for 2014.

Three-pronged investment approach

The UBS research team suggests investors consider three specific actions to derive more out of their portfolios. The research team’s suggestion stems out of the 2013 Nobel Prize-winning research of Robert Shiller and Eugene Fama viz.: change your liquidity preference implying buying illiquid securities, change your time horizon or invest in managers having an edge through better market knowledge.

The UBS analysts believe despite the market being hard to beat, adopting these suggestions would provide investors the best probability to do so.

While reviewing the performance of 2013, the analysts point out that while diversification worked last year, portfolio returns trailed the stellar across-the-board performance witnessed in 2012. Most investors received portfolio returns that were at least sufficient to keep them on track toward achieving their financial goals. However, the investors might face challenge in 2014 as they face higher equity market valuations and still-low bond yields.

Cash seldom a productive asset

The UBS analysts note both empirical and anecdotal evidence suggest investors still feel stung by the losses they experienced in 2008 and hence continue to hold larger-than-normal allocations of cash. Citing the household balance sheet data collected by Federal Reserve, the analysts note deposit holdings, which include everything from checking accounts to money market fund assets, remain at elevated levels when compared to levels during previous economic expansions. The following graph highlights this aspect:

Elevated levels of cash Productive Assets

However, the UBS analysts point out that cash has seldom been a less productive asset than it is today.

High opportunity cost of disengaging from financial markets

The analysts believe investors can justify holding large cash allocations if interest payments on cash deposits exceeded the prevailing rate of inflation. However, since 2009, the opportunity cost of disengaging from financial markets by adding large cash positions has been severe. For instance, U.S. equities have nearly tripled since the bottom, while Treasury bills have returned only 1% cumulatively.

The UBS analysts point out that though the high inflation period during the 1970s and early 1980s may provide a strong case for holding cash, the real returns on cash, after adjusting for inflation, were just as bad if not worse between 2009 and 2013. The analysts anticipate this trend to continue for at least the next two years. The following graph supports the analysts’ views:

Reduced purchase power from holding cash Productive Assets

Despite US equities posting their best yearly return in 2013 in nearly 15 years, the UBS analysts believe that new equity market highs are not an uncommon event. They point out that since 1940, the S&P 500 has been at an all-time high 22% of the time and experienced slightly above average gains following 12-month periods with over 20% return. This can be evidenced from the following graph:

S&P 500 gains following market surges Productive Assets

Hence the analysts suggest investors should initiate a systematic process to deploy cash into more productive assets.