Cash mountain brings both hope and difficulty

A man flips through stacks of $100 bills in a file photo.

LONDON (Reuters) - A mountain of cash sits on the edge of financial markets, waiting to tip in when confidence is restored in riskier assets. For investors, this is both an opportunity and a problem.

While it brings hope to those banking on a sharp reversal in investments later this year -- those looking for a V-shaped economic and market recovery -- it is also causing difficulties because money is not being put to work.

"Basically, what we are seeing is hoarding of liquidity," said John Stopford, head of fixed income at Investec Asset Management. "It's distorting pricing. It's a problem."

Plenty of evidence exists to show investors stocking up on huge levels of safe-haven cash in the face of credit market gyrations, a worsening global economic outlook and volatile financial markets.

The latest Reuters asset allocation polls, for example, show leading international investment firms holding some 5.9 percent of their mixed-asset portfolios in cash. It compares with a long-term average of 4.5 percent.

A steady move into cash is also seen in Merrill Lynch's monthly poll of fund managers. Some 51 percent were overweight in cash in March, compared with 48 percent in February and 43 percent in January.

Flow data from fund researcher EPFR Global quantifies the trend. It shows a net $140.9 billion flowing into money market funds in the first quarter. To put this in context, developed market equities saw outflows of $69 billion.

Speakers at this week's Reuters Hedge Funds and Private Equity Summit went further, indicating that the cash hoarding may be far more widespread than just in traditional fund management firms.

Bill Maldonado, head of alternative investments at HSBC Halbis Capital Management, said that cash was building up at investment bank departments that lend money to hedge funds.

"What we hear and see anecdotally is that the prime brokers are sitting on the biggest ever cash balances," he said.

Simon Walker, head of the British Private Equity and Venture Capital Association, meanwhile, said private equity funds are also sitting on a cash pile, waiting to either buy new companies or beef up those they already own.

GOOD CASH, BAD CASH

The positive side for investors is that this cash is generally not tied up and can quickly be churned into new investment when the time is right.

It is already happening on a selective basis.

"We have a lot of powder we've kept dry," Bernard Oppetit, chairman and chief executive of hedge fund Centaurus Capital, told the Reuters summit. It was to be used, he added, for opportunities that would crop up in the credit market.

"We are now at a stage where we can find some very attractive pieces of paper to buy, both loans and bonds. This is what we've been doing in the last couple of weeks," he said.

Societe Generale takes a similar line in its second-quarter strategy. "We overweight cash," it said in a note, "in order to seize opportunities linked to the U.S. entry into recession and contagion effects on the rest of the world."

But while this may lift some assets in coming weeks, the cash hoarding overall means the broad market is not getting the fuel that it needs.

"You can see it showing up in money market funds," said David Bowers, joint managing director of Absolute Strategy Research. "People are just not putting cash to work."

Much of it, for example, is being driven into the shortest of short-term government debt because higher-yielding lending and secondary money market trading has dried up in the credit crisis.

This means investors are getting very little for their money, as exemplified by U.S. three-month Treasury bills US3MT=RR yielding a near historically low 1.3 percent.

It is also not good news for global investors that private equity firms and hedge funds are holding back.

There has been a sharp reduction in mergers and acquisitions as a result of the former, while the latter shows borrowing for investing to be out of favor at the moment.

"We ... are using practically no leverage," Centaurus's Oppetit said.

It all leaves investors waiting for that so-far elusive moment when caution eases and the cash mountain turns into a welcome landslide.

(Additional reporting by Laurence Fletcher and Simon Challis; Editing by Ruth Pitchford)