The Federal Reserve has made it clear that short-term rates are on lockdown until the unemployment rate drops from its current 7.6 percent to 6.5 percent. 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, would own cash when it's a guaranteed losing proposition?
Some standout value fund managers, that's who.
The $1.1 billion Weitz Value and $980 million Weitz Partners Value funds each have cash stakes that are close to 30 percent. At the $10.6 billion Yacktman Focused fund, cash has crept up from 14 percent a year ago to 19 percent. The $1.3 billion Westwood Income Opportunity has about 16 percent in cash, more than double what it had at the start of the year. Cash makes up about 28 percent of assets in the $8.9 billion IVA Worldwide Fund, up from 10 percent a year ago, and is 33 percent of the $508 million GoodHaven fund, up from 19 percent a year ago.
Those are some seriously contrarian positions. The average diversified U.S. stock fund has less than 5 percent in cash, according to Morningstar. For funds such as IVA Worldwide that fall into the "world allocation" fund category and invest globally across a wide range of asset classes, the average cash stake is below 15 percent.
There's no big macroeconomic prediction fueling the move of these value managers into cash. Just some simple investing discipline as managers pare positions in stocks they bought at deeply depressed prices. The Leuthold Group reports that the median price-earnings ratio for large-cap value stocks is 13 percent to 25 percent above its long-term historic norm; large-cap growth stocks trade at an 8 percent to 10 percent discount to their historic norm.
“After taking profits on stocks that have risen close to what we believe is their value, we aren't finding enough mispriced securities to redeploy that cash into,” says IVA Worldwide co-manager Charles de Vaulx. He'd rather know with certainty that he'll lose a little by holding cash “than stay invested in stocks I don't think offer enough value and lose a lot.”
The managers at Weitz feel much the same way. Investing nirvana is a stock that trades at a 40 percent to 50 percent discount to their estimate of its market value. As holdings have rallied — Weitz Partners Value is up more than 32 percent over the past 12 months, three percentage points ahead of the S&P 500 — the value proposition has dissipated. Wally Weitz estimates that the current price-to-market value for the remaining stocks in Partners Value “is in the high 80 percentage range, which is probably close to an all-time high for us.” Thus, so too is the fund's cash position.
“We tell people that to do the best we can means there will be times we will opt to wait in cash for the next opportunity,” says Drew Weitz, Wally's son. Over the past 15 years both Weitz funds have outpaced the S&P 500's return by more than two percentage points.
These managers aren't permabears. Tom Forester, who has 25 percent of his Forester Value fund in cash, is quick to note that in 2009 his fund had a 4 percent cash position. “I think equities are phenomenal, at the right price and in the right environment,” he says. It's just that he sees little of either right now: “Central banks are driving the markets higher, not fundamentals.”
“There's always a constant intellectual dance deciding whether to own something that is fairly valued or hold cash,” says Dowe Bynum, co-manager of the Cook & Bynum fund. In his fund, which prowls for stocks that deliver the classic "margin of safety" that is a cornerstone of value investing, cash is winning at more than 40 percent of assets.
Cook & Bynum managers aren't selling out of positions, but as new money arrives they aren't adding to existing positions that include Microsoft, Wal-Mart, Coca-Cola and Berkshire Hathaway. Nor is their list of potential new stock holdings trading at buy-worthy valuations now. Bynum says it would take a 10 percent to 15 percent drop in any of their existing holdings to consider putting cash to work.
It's not just rising stock valuations pushing some managers to hold more cash. The Westwood Income Opportunity fund has a mandate to invest in both stocks and bonds, and it deems bonds too pricey. “The only way for value to be created in fixed-income right now is for rates to rise, and I don't want to be there while the value is being created,” says co-manager Mark Freeman. He expects this transitional market for bonds to last six months to a year. His solution: Use cash as a proxy for bonds.
That means Freeman is giving up some current yield, which is not easy for a manager whose fund has 'income' in its name. Yet while others lament the opportunity cost of holding cash — that negative return — Freeman sees positive future returns. “It not only helps me manage volatility, but as we progress through this transitional market that cash will give us the flexibility to take advantage of new values once they're created.”
As the saying goes, "the time to pounce is when there is blood in the street," says IVA Worldwide's de Vaulx. “We're not nervous Nellies. We are waiting to pounce.”