Why Allocating To Cash May Not Be The Best Strategy

In my experience, a large majority of investor portfolios that I come across are strategically allocated anywhere from 1% to 10% in cash. Quite often the objective for this strategic cash allocation is to disinvest a fraction of portfolio beta and, therefore, reduce overall volatility. An allocation to cash makes sense—particularly to fund spending requirements over the short term—but of course, the greater the more defensive positions, the less potential upside participation there is.

What if there were “asset allocation” strategies that reduced volatility but still participated on the upside?  

In February 2016, WisdomTree launched a strategy called the WisdomTree CBOE S&P 500 PutWrite Strategy Fund (PUTW) that tracks the CBOE S&P 500 PutWrite Index (PUT). This strategy is designed to collect premiums by selling cash-collateralized S&P 500 Index put options every month. Thus, when complemented with an equity portfolio, it can help reduce portfolio beta and potentially provide higher risk-adjusted returns. 

My analysis below proposes an allocation to the Put Write Fund as an alternative to cash or short-duration fixed income to attain higher upside participation while managing volatility in a way that looks similar to allocations of cash and equities. With PUT having nearly 10 years of live track record, we now have the luxury of analyzing results backed by a longer period of time.

PUT—Measuring Risk Reduction Properties by Comparing to S&P 500 and Cash Blends

In the chart below, we are starting with a 100% allocation to the S&P 500 (Portfolio A, top right) and then either blending cash (dotted green line) or PUT (blue curve) in increments of 1%. What we see in this chart is that for every cash allocation, investors could have improved their total returns by blending the S&P 500 with PUT instead of cash.

An investor allocating 5% to cash could have achieved similar volatility with higher returns by allocating 15% to PUT. A few other key cash allocations and corresponding PUT allocations are listed below.