As the market continues its upward rise, we believe the emphasis we place on our managers holding cash makes more sense than ever. With most Mutual Funds lagging the S&P 500 Index for 10 years, we feel it is important to go against the crowd. For example only 3% of the 7,500 U.S. equity funds tracked by S&P Capital IQ recently had cash positions of 10% or higher, while 97% were almost fully invested.
If the average fund holds no cash, then it signals that most funds are fully invested and thus could lead to an overvaluation of the market. This in turn could be a signal to hold more cash as there are fewer bargain opportunities when the market is fully invested in. That gives ammo to money managers who say "cash is trash." A federal funds rate stuck near zero means cash will continue to deliver negative real returns for some time.
Who in their right mind, the standard Wall Street taunt goes, who would own cash when it’s a guaranteed losing proposition?
Some standout value fund managers, that’s who. Warren Buffett of Berkshire Hathaway, Prem Watsa of Fairfax Financial Holdings, and Bruce Flatt of Brookfield Asset Management have all recently increased their cash positions with the prospect that there is a lack of quality buying options. As Warren Buffett puts it, “There will be some incident, it could be tomorrow. At that time, you need cash. Cash at that time is like oxygen. When you don’t need it, you don't notice it. When you do need it, it’s the only thing you need. We operate from a level of liquidity that no one else does”.
Berkshire Hathaway has perhaps the largest cash position of these holding. With over $64.56 billion in cash and equivalents and another $46.54 billion in short-term investments (which can essentially be considered cash for liquidity purposes) reported at the end of the second quarter of 2018, Berkshire Hathaway has a total of $111.1 billion at its disposal. This represents nearly one-fifth of the company’s market cap! While this is significantly higher than the typical $20 billion dollar cash cushion Buffett prefers to operate with, the cash position has gone down from $116 billion at the end of 2017. And despite a $2.4 billion increase in cash from last quarter as a result of the acquisition of Monsanto by Bayer, it appears that all excess cash generated by Berkshire’s operating business was reinvested. Such a large cash position is still a clear signal that Warren Buffett believes the market is full and that he would rather wait for bargains than invest at high prices. This is not a new strategy for investors like Warren Buffett as he has been known to increase his cash position in times when he feels like there are no options, which has contributed to his 19.1% average annualized return on book value since he took over Berkshire Hathaway. He would rather wait and take short term losses equivalent to inflation rather than expose himself to unnecessary risk. With Buffet’s aptitude for acquiring entire business, which hasn’t happened since 2015, perhaps the large cash position could be utilized if a company were to be found trading at an attractive valuation. As a final option, Buffett could use the cash to buy back stock. Recently, Berkshire’s board of directors amended the repurchase plan, getting rid of the stipulation that the shares must be trading at less than 120% of book value2. So now Buffett can buy back as many shares as he would like whenever he feels like Berkshire’s price is undervalued. This will be something interesting to watch going forward as share repurchasing will give a key indication of how Buffett views his company.
Prem Watsa, CEO of Fairfax Financial, is another value manager, who has compound annualized returns on book value of 19.5% from 1985 through 2017. The stock price for Fairfax has appreciated at a compounded annualized rate of 18.1%, keeping almost in line with the book value growth1. Recently, he has significantly increased his cash position due to perceived uncertainty and high prices. Fairfax Financial Holdings sold 90% of its holdings in long term treasuries to bring its cash position up to one-third of the total portfolio, that is up 19% from June 2016 with total cash and equivalents position of $10 billion. In a quarterly conference call, Prem Watsa explained his views on the importance of holding cash and how it has helped them historically:
“As far as the 30% cash, remember, that can change. So in 2008, and we had this position in 2007, in 2006. 2008, things turned the financial markets. Stock markets dropped… about 50%… And Tom, the only people who could benefit from that were the people who had cash or government bonds. And so we are conscious of that in our history. Cash gives you options, gives you the ability to take advantage of opportunity but you have to be long-term. We have built our company with a long-term view. Our long-term results are excellent. For example, in 2007, ’08, and ’09, the 3 years, 2007, 2008, 2009, we made $2.8 billion after tax, our book value went up by 150%. Since that time, we haven’t done a lot. But we’ve said to our shareholders that we are long-term focused, our results are lumpy and we never know when it can change. But the cash gives us a huge advantage in terms of taking advantage of opportunity as and when they come. At the moment, we don’t think they’re many, so we are building cash.”
A topic of consideration however is the impact these cash positions have on returns. Take for example a fund with a 33% cash position over the course of a year. The fund returns 12% in net capital appreciation. When you adjust for the large cash position the returns were actually 33% higher for money that was exposed to the market (i.e. invested capital). Therefore, the return for the invested capital within the fund was 16%. Keep this in mind when evaluating fund performance over specific periods and especially when comparing those returns to an index or peer funds.
“If you have cash, you may remain safe in the shelter of the harbour until the storm passes” - Frank Martin
"The hardest thing to do in investing is not the decision to buy or sell but to sit idle even if that means allowing the build-up of some cash" - Christopher Begg
There is no guarantee that active asset management will outperform a buy and hold approach to investing. The views expressed are not necessarily the opinion of FSC Securities Inc. and should not be construed directly or indirectly, as an offer to buy or sell any securities mentioned herein. Investing involves risk including the potential loss of principal. No investment strategy can guarantee a profit or protect against loss in periods of declining values. Past performance is no guarantee of future results. Please note that individual situations can vary. Therefore, the information presented here should only be relied upon when coordinated with individual professional advice.
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About The Retirement Group
The Retirement Group is a nation-wide group of financial advisors who work together as a team. We focus entirely on retirement planning and the design of retirement portfolios for transitioning corporate employee. Each representative of the group has been hand selected by The Retirement Group in select cities of the United States. Each advisor was selected based on their pension expertise, experience in financial planning, and portfolio construction knowledge.
TRG takes a teamwork approach in providing the best possible solutions for our clients’ concerns. The Team has a conservative investment philosophy and diversifies client portfolios with laddered bonds, CDs, mutual funds, ETFs, Annuities, Stocks and other investments to help achieve their goals. The team addresses Retirement, Pension, Tax, Asset Allocation, Estate, and Elder Care issues. This document utilizes various research tools and techniques. A variety of assumptions and judgmental elements are inevitably inherent in any attempt to estimate future results and, consequently, such results should be viewed as tentative estimations. Changes in the law, investment climate, interest rates, and personal circumstances will have profound effects on both the accuracy of our estimations and the suitability of our recommendations. The need for ongoing sensitivity to change and for constant re-examination and alteration of the plan is thus apparent.
Therefore, we encourage you to have your plan updated a few months before your potential retirement date as well as an annual review. It should be emphasized that neither The Retirement Group, LLC nor any of its employees can engage in the practice of law or accounting and that nothing in this document should be taken as an effort to do so. We look forward to working with tax and/or legal professionals you may select to discuss the relevant ramifications of our recommendations.
Throughout your retirement years we will continue to update you on issues affecting your retirement through our complimentary and proprietary newsletters, workshops and regular updates. You may always reach us at (800) 900-5867.
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