Performance of Excess Cash Holding Portfolios: Evidence From the United Kingdom

ABSTRACT In this study, we investigate the impact of excess cash holdings on the performance of UK portfolios during periods of high economic uncertainty from 1980 to 2018. We argue that macro‐level uncertainty poses significant risks to firms. A high level of uncertainty also enhances the value of cash holdings, as cash‐rich firms are more likely to demonstrate financial flexibility and overcome financial constraints. Consistent with our prediction, we document that portfolios with high cash holdings outperform those with low cash holdings by 7% after adjusting for the Fama–French 25 portfolio sort. Our results are robust after adjusting for asset pricing factors. Our empirical evidence suggests that the trade‐off between the benefit of carrying and the cost of holding excess cash depends on the macro‐level of uncertainty, highlighting the value of cash as a safe haven during such times. In evaluating how limits to arbitrage affect the outperformance of excess cash holding portfolios, we find that the effect dissipates for stocks with high transaction costs. Furthermore, we document that the outperformance of the excess cash holding portfolio is pronounced during periods of low investor sentiment. In general, the study's results are economically meaningful for investors.