What happens when asset managers believe that equities are still the best and perhaps only play in town, but that shares, particularly in the U.S., are close to being fully valued, and long-term bonds are risky? Answer: Cash positions spike, as wealth managers park money in cash or cash equivalents and wait for dips in the market before buying more stocks.
 
“We think stocks are going to deliver reasonable returns. The problem is, you’re not going to get return from bonds, so we’ve put some risk mitigation into cash,” says Seth Masters, chief investment officer at Bernstein Global Wealth Management.
                 
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Photograph: Brad Trent for Barron’s
 
There’s an important nuance here. The larger-than-normal liquid positions that we are spotting don’t mimic the defensive crouch seen in a recession. Rather, they are often cautious and temporary sideline holdings, awaiting the right buying opportunities.
 
That, in essence, is where our 40 asset managers stood at the end of 2014, a story that can be found buried deep inside our asset-allocation table of America’s largest asset managers, on pages 28 and 29.
 
At first blush, allocations by the group of 40 haven’t changed much because of contradictory and uncertain views. Overall stock allocations average 51%, the same as a year ago, but U.S. stock holdings are up slightly, to 33% compared with 31% last year. Counterintuitively, with U.S. interest rates soon to rise, allocations in fixed income are also slightly higher this year -- at 27% versus 26% last year.
 
But that’s our story: A good portion of those fixed-income holdings are due to asset managers quietly parking cash in “cash equivalent” short-term fixed-income instruments. Among them are a smattering of corporate bonds, commercial paper, and mortgage-backed securities, and a bigger proportion of asset-backed securities, such as those backed by consumer loans, mortgage-servicing fees, and communication-tower lease revenues.
 
JPMorgan Chase, Highmount Capital, Wilmington Trust, and Barclays are some of the wealth managers that have increased cash or cash-equivalent investments in this way. Consider Brown Brothers Harriman, which had 27% in cash and equivalents on hand at year-end 2014, by far the largest stash -- some to offset risk, but most on hand to deploy on market dips, says the firm’s chief investment strategist, Scott Clemons.
 
Here is why Clemons’ cash position isn’t easy to spot in our table: Brown Brothers has just 3% in pure cash, but it has quietly shifted 24% of its portfolio into ultrashort-term instruments that are lumped into the firms’ fixed-income bucket.
 
It’s an opportunistic holding. When the oil-price collapse triggered a fall in shares in early December, Brown Brothers added modestly to stockholdings. With cash levels still over 20%, Clemons said he is poised to pounce further into emerging markets, encouraged by temporary oil-price-induced weaknesses.
 
Brown Brothers Harriman is not alone. Among other firms with cash embedded in their fixed-income allocations are Genspring, with 8% of its total portfolio; Atlantic Trust, with 9%; and Barclays, with 7%. It raises the question: Why?
 
BLAME IT ON UNCERTAINTY. Wealth managers are all privy to the same data, but they’re coming up with very different conclusions about the meaning for investors. It’s a sign of abnormal times.
 
“Earlier in the recovery cycle, people were more certain in their allocations and there was more uniformity in outlooks, but now everyone realizes growth isn’t bouncing back as it has historically,” says Bruce McCain, chief investment strategist at Key Private Bank. “Since you can’t frame what’s going on based on historical trends, you get a wider range of ideas about how to exploit what’s happening.”
 
Barron’s annual asset-allocation survey typically finds strong majority opinions, such as last year’s 75% that backed an increase in foreign developed stocks. But in this year’s survey, for which data were gathered in December, only U.S. stocks got a thumbs up, with 56% of wealth managers recommending adding a touch more. In other asset classes, a roughly equal number of wealth managers were positive or negative.
                               
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Photograph: Brad Trent for Barron’s
 
 
The current, anything-seems-possible environment set the tone for the discussion at a year-end JPMorgan Private Bank meeting, during which investment analysts found a high probability for both bull and bear markets for 2015, says Kate Moore, the bank’s chief investment strategist. “We found the number of realistic outcomes are much greater than 12 months ago,” she says.
 
Blame the central banks, says Tim Leach, chief investment officer of U.S. Bank Wealth Management. “We’re in an era of the activist central banker employing heavier-weight strategies as opposed to modest incremental shifts at the margin,” he says. “Now you have to think, ‘What happens when the 800-pound gorilla throws a piece of furniture into the ring and changes everything?’ ”
 
There is, in short, a sort of mayhem out there: In the first six years of the recovery, central bankers were all pulling the sled in the same direction. Now, the Federal Reserve is heading into a tightening cycle, the European Central Bank wants to add more stimulus, and Japan needs to.
 
What that means, in concrete terms, is that most wealth managers continue to maintain the overweight positions in U.S. stocks that they began building up in 2013, even though about a third, such as UBS, Goldman Sachs, Janney Montgomery Scott, PNC Asset Management, and BMO Private Bank, have since lightened their positions somewhat.
 
With valuations in the top quartile of their historical range, there’s reason for concern, “but the environment’s still reasonably good for risk-taking supported by central-bank policy. Fundamentals are OK, and profit margins are good,” says Christopher J. Wolfe, chief investment officer at Merrill Lynch Wealth Management Private Banking and Investment Group.
 
Technology stocks are a favorite, based on the view that U.S. companies will finally begin to make significant upgrades in their technological infrastructures. The financial sector is also poised for a lift.
 
Once interest rates start rising, which most expect this year, “it’ll be the ground zero for profit-making” at the banks, says Hans Olsen, global head of investment strategy at Barclays Wealth and Investment Management.
 
Banks will not only be able to charge higher rates on loans, but low oil prices mean consumers have more money in their pockets and are likely to begin borrowing more.
 
Banks were already strong performers last year, up 15% versus 14% for the Standard & Poor’s 500, but Brett Nelson, managing director at Goldman Sachs Investment Strategy Group, points out that their price-to-book ratios -- the favored valuation method for banks -- are in the lowest third of their range since 1990.
 
Meanwhile, in foreign developed stocks, uncertainties about central banks’ abilities to further stimulate economies produced opposing views tugging this way and that, all over the lot.
 
“The only thing you can hang your hat on in Europe is central-bank stimulus,” says Paul Chew, head of investments at Brown Advisory. “We find it difficult to invest in a market when easing will be the driving factor, not the fundamentals.” Brown Advisory, UBS, and Atlantic Trust are among the firms that agree it’s best to wait before stepping up investments in European stocks.
 
But for Wells Fargo, Deutsche Bank, and Glenmede, valuations on European stocks -- trading near a 40% discount to U.S. counterparts -- are low enough to offset other concerns.
 
“Where we’d normally turn to U.S. companies in industrials, energy, and health care, now we’re looking at European companies. We compare Johnson & Johnson maybe to GlaxoSmithKline for better value. Or within the energy sectors, ExxonMobil to Total,” says Mark Luschini, chief investment strategist at Janney Montgomery Scott.
 
There’s a similar range of views on Japan’s prospects. While some wealth managers have lost confidence in Prime Minister Shinzo Abe’s ability to drive much-needed stimulus, others are encouraged by his success in devaluing the currency and bringing about at least modest reform.
 
But whatever the outlook, all expect both the yen and the euro to further depreciate against the almighty dollar this year. “If you don’t hedge the currencies, you’re talking about cutting your returns in half,” warns Larry Adam, chief investment strategist of Deutsche Bank Private Wealth Management.
 
In emerging markets, better-than-expected growth is likely in Mexico, South Korea, and Poland, claims Chris Hyzy, U.S. Trust’s chief investment officer. In backing his call, he has bumped the firm’s emerging-market allocation from 5% to 6%. Mexico will benefit from its strong trading ties with the U.S., as domestic growth north of the border picks up, he figures.
 
“Korea is a direct beneficiary of the advancement of the tech cycle, and Poland is a conservative way to invest in the growing middle class of Eastern Europe and the outsourcing that’s happening in other parts of Europe,” he says. Brown Brothers Harriman maintained its overweight 10% exposure to emerging markets that it established in early 2014, but is avoiding companies with exposure to the U.S., says chief investment strategist Clemons.
 
Wealth managers generally prefer Asia over Latin America, and in some cases are betting on frontier markets, believing that the economies have stabilized and corporate earnings and gross-domestic-product growth are poised to improve. “We’ve gone to a modest overweight with additions to India, the Philippines, Indonesia, and Vietnam,” says Garrett D’Alessandro, chief executive officer at City National Rochdale.
 
FIXED INCOME is a different mess. In the U.S., the looming question is whether interest rates will begin rising sooner or later, and how quickly they’ll go up. But regardless of timing, the view is dour.
 
“There’s not a whole lot of upside you can earn when you’re at a 2% yield on the 10-year Treasury,” says Brown Advisory’s Chew.
 
Many wealth managers recommend paring back U.S. high-quality bonds, in some cases to historic lows. Constellation Wealth, for example, reduced its overall fixed-income allocation by a third, and has just 10% devoted to U.S. high-quality securities.
 
They are not alone. Wells Fargo reduced its fixed income by 21%, to 17%, of which only 6% is now in core U.S. bonds. “If you think historically of what a balanced portfolio looked like -- 60% stocks and 40% bonds -- to have such low levels in high-quality fixed income tells you we’re in very different times,” explains David Donabedian, chief investment officer at Atlantic Trust, which has 18% of its portfolio in high-grade corporate and municipal bonds.
 
Alternatives? While private-equity allocations haven’t changed in the past year, firms are putting more into U.S. and foreign private debt to eke out mid-to-high single-digit yields. But the flat allocation doesn’t reflect the growing number of families that are investing directly in private equity. (For more on this, see our private banking story, “The $800 Million Club.”)
 
Real estate holdings are down, primarily on the volatility that will hit real estate investment trusts once interest rates creep up, and some of last year’s sweet spot -- investing directly in multifamily housing, for instance -- has been bid up, says Sam Katzman, chief investment officer at Constellation Wealth Advisors. He’s increasingly lending to developers of multifamily housing. “We can get a decent return -- yields are in the 12% to 15% range -- and still get the asset as collateral,” he says.
 
Commodity exposure has been cut further this year, with poor global demand, a strong dollar, and falling oil all contributing to the bearish sentiment. And hedge funds posted disappointing returns in 2014 yet again, prompting Highmount Capital and Key Private Bank to reduce allocations to zero, and others to scale back.
 
But many firms continue to rely on hedge funds to replace bonds as a portfolio ballast, and aim to seek out hedge fund performance uncorrelated to the stock market. Citi Private Bank’s David Bailin, for example, says he likes event-driven hedge funds that are actively involved in mergers and acquisitions.
 
“There’s sizable money to be made on those deals,” he says, noticing a high level of mergers-and-acquisitions activity as companies become more concerned about how to create value. That’s still not a convincing argument for everyone. Looking across asset classes, Barclays’ Olsen summed up the investing landscape in 2015, quipping, “It’s going to be a grind.”
 
On that point, at least, wealth managers can agree.