When markets are down, should you be turning to cash?

In early 2022, we were reminded of what volatility can truly mean in terms of performance. Many single stocks (particularly in the growth space) experienced painful downward swings from their highs in 2021, and the Nasdaq confirmed it had entered a bear market. While it can always be tempting for individual investors to jump ship and turn to cash for the short term, it can pay to think more like an institutional investor.

During times when stocks expected to generate excess returns are not working out (or take longer to deliver than usual), it’s natural that cash can feel like a safe option. However, cash can quickly lose value, especially during periods of high inflation.

Let’s take a look at how institutional investors often turn to ETF liquidity sleeves instead of cash, to keep their investments working for them, and then we’ll examine ways that individual investors can mimic this strategy.

How liquidity sleeves work

For many institutional investors, the best stock picks that they incorporate into their funds can take some time to play out. If an investor then decides to pull their money out of the fund, the fund manager would have to decide which of their very carefully selected stocks they would have to sell. As you can imagine, this can be a difficult decision.

To avoid having to do that, many institutional investors hold a liquid ETF sleeve within the fund, which can be sold very easily and with little impact on the fund’s strategy, minimizing any effect on departing and remaining holders of the fund.

For institutional investors, this ETF sleeve keeps cash invested in the market, which can swing quickly to the upside as well during market volatility. This allows the fund to benefit fully from those moves, in comparison with a cash position, which would lose out on gains from market upswings.

How individual investors can mimic this liquid ETF sleeve strategy

During times of high volatility, investors may be tempted to sell all or some of the stocks in their portfolio (especially those that have dropped considerably in value), to prevent even greater losses. However, this is a typical emotional investing decision that we’re always warning against, because overweighting cash is unlikely to help you reach your investing goals. Always keep your investing goals and investing time horizon in mind when making changes to your portfolio.

The problem with selling in a declining market is that you can miss the bottom of the market and it can then take off again without you. Buying back in after a large, missed upswing, can have a drastic negative impact on your portfolio’s value.

So, instead of turning your stocks or other assets into cash, replacing them with a liquid index ETF can allow you to divest of unfavourable stocks in the current market conditions, without leaving the market (and therefore missing out on market upturns).

How to use ETFs as liquidity sleeves

Let’s look at some examples of how to use ETFs to stay invested, rather than turning to cash. Let’s say you held a bunch of US growth stocks that performed brilliantly in the past but were now plummeting. By moving that money into an ETF that holds a much broader range of US companies (such as the Mackenzie US Large Cap Equity Index ETF) you’ll immediately have considerably greater diversification.

This means that you will be well positioned to benefit when stocks rise. When this happens, that is your signal to start considering selling some of your position in the ETF to buy back the growth stocks that you valued before. This way you avoid the guaranteed loss that inflation brings to cash and you’ll benefit if there is a market upturn.

You could also consider an ETF like the Mackenzie Global Sustainable Dividend Index ETF, which would provide extra diversification by holding dividend-paying companies, many of which are located outside of the US.

In inflationary environments, an ETF like the Mackenzie Canadian Equity Index ETF could take advantage of the strong performance of both financials and commodities.

Another advantage of using these ETFs as liquidity sleeves is that they have low management fees (starting as low as 0.04%), so it won’t cost you much to stay invested.

Find out more about using ETF liquidity sleeves

To find out more about how ETF liquidity sleeves could benefit your portfolios, advisors, reach out to your Mackenzie sales team and investors, talk to your financial advisor. 

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