Goldman Sachs (GS) analyst David Kostin argues that investors are wildly confused about “cash on the sidelines,” how much there is, and how much of it is likely to flow into equities.
The report cites numerous conversations in which the number “$3 trillion” has come up for the amount of cash that can be put to work. But that’s nonsense, because it’s based on this simplistic idea that money market funds (cash on the sidelines) are mostly would-be equity investors, and that they’d draw it all down.
In reality, they’ll fall to about $2 trillion, but even then much of it won’t go into equities — a lot will go into bonds. And it’s not necessarily the appetite for risk that will cause outflows, but rather the paper-thin yields on these money market funds.
The relative flows suggest re-risking in the mutual fund complex has been limited to
credit and that the risk appetite of mutual fund investors has not yet sufficiently
increased to benefit equity funds. Of course, equity mutual funds are not the only avenue
for exposure to the equity market. Individual investors can also gain access to the equity
market via directly held shares and new share issuance – two categories that have
benefited from increasing risk appetite according to the Federal Reserve’s flow of fund’s
data and our analysis of net equity issuance in the US.
While some assets may flow up the risk curve from credit funds to equity funds, we
expect to see only a gradual reallocation over the next six months. Our credit strategy
team expects bonds to continue to rally over the next six months due to a combination of
supportive macro data and continued positive fund flows. In fact, credit spreads are at risk
of overshooting if the robust flow of funds into the asset class continues. Consequently,
credit is likely to become increasingly less attractive on a relative basis over the course of
2010. This forecast, coupled with a modest economic recovery, could encourage some
investors to move their assets from credit funds to equity funds. We do not expect such a
shift to occur rapidly or in large size given the fact that the credit mutual fund market is
$1.3 trillion smaller than the US equity mutual fund market ($2.1 trillion versus $3.4 trillion)
and given the fact that funds invested in credit tend to be slower moving than funds
invested in riskier asset classes. The large pool of assets still in cash suggests that we may
see investors leapfrog credit funds and move directly from cash to equities in addition to
any modest re-allocation from credit to equity.