By Tom Brakke, CFA
"Cash is trash" goes the saying in the market these days. Cash
in a bank account yields virtually nothing, and near-cash
investment vehicles like money market funds and certificates of
deposit offer the prospect of paltry returns. No wonder investors
are busy reaching for yield (and grabbing extra risk with that
At other times, however, you hear market participants express
another sentiment entirely: "Cash is king."
Complete opposites in their meanings, the two sayings point to
the bipolar feelings that many investors have about holding cash.
It either depresses them or excites them, depending on the phase of
the market. When things are good and most assets are doing well,
cash is indeed thought to be trash. But when markets are under
pressure and the only thing holding its value is cash, a sizable
position in it makes you feel like a king.
The 30-year decline in interest rates has led to today's skimpy
rates on cash and investors' general aversion to it. During that
time, there has also been a big change in how cash is viewed by
those who evaluate professional portfolio managers.
I entered the business in 1983. And for the next decade or so, on
average, cash in stock mutual funds fluctuated in the neighborhood
of 10% of total portfolio assets. Since then, it has plummeted and
is now usually in the 3%-4% range.
Around the time that decline started, I was managing portfolios
for institutional investors as part of a team that was a "sector
rotator." Basically, a key part of what we did was to try to
overweight or underweight the various sectors of the S&P 500
Index, depending on where we thought we were in the economic/market
cycle. Part of our marketing message to clients was that "cash is a
sector" -- that is, we looked at the use of cash as a weapon in our
investment strategy to deliver outstanding long-term
But somewhere along the way, it became less common for all types
of managers to use cash as a weapon. The decline in yields played a
part, and the great bull market created a generation that believed
cash was a drag on portfolio return. In addition, there was a
significant shift in how clients and gatekeepers (e.g., consultants
and advisors) thought about the use of cash, which can be
summarized in a comment that became a standard retort from them:
"We don't pay you to manage cash."
That simplistic view caught on. But a manager with some cash is
not "managing cash"; he or she is managing exposure to the
investment possibilities available in his or her area of expertise
-- and investing in a way that takes advantage of cash to capture
the opportunities that can generate returns. To limit a manager's
use of cash is to fail to understand the nature of the
decision-making process. In any case, if a manager generates good
returns with a load of cash that seems heavier than it should be,
who cares? The presence of that cash may be one of the key reasons
for the outperformance.
Many great portfolio managers have held cash positions that
would be viewed as too high by today's gatekeepers. Some of them
just liked having cash around so that when they identified an
opportunity, they wouldn't have to sell something to be able to
invest in it. Others let cash build up if they couldn't find stocks
that met their parameters; the cash was simply a residual of their
decision-making process. Still others looked at overall market
characteristics and adjusted their exposure accordingly, using cash
to tailor the risk of their portfolios.
All managers should be held accountable for their performance
over a reasonable time frame, and those who run with heavier cash
positions should be judged on whether their stated use of cash
actually contributes to an attractive performance profile. Those
kinds of evaluations require careful consideration of how value is
added, which is much more challenging than merely deciding that a
certain level of cash in a portfolio is "too high."
But many gatekeepers revert to the latter approach, saying that
it is their job to allocate assets and a manager's job to manage
them within certain confines. Lost in that approach is the
information about a particular asset class that the person closest
to it can see (and use to improve performance). Cash is not a
typical asset class for allocating, and managers should not be
hamstrung in their effective use of it.
This past Oct. 19 was the 25th anniversary of the Black Monday
stock market crash. Some managers used the volatility of that
period to add shares in notable companies at rock-bottom prices.
Their ability to do so made their clients a great deal of money --
and they would not have been able to capture those opportunities
had they been limited in the cash that was available to them.
So, cash is not trash, even when it seems to be. It has real
value, a point made in a recent
Globe and Mail
concerning what Warren Buffett thinks about cash. As with many
other aspects of investing, Buffett challenges the industry norms.
According to his biographer, Alice Schroeder, "Mr. Buffett
[believes that] cash is not just an asset class that is returning
next to nothing. It is a call option that can be priced. When he
thinks that option is cheap, relative to the ability of cash to buy
assets, he is willing to put up with super-low interest rates."
That's the kind of analysis that should be brought to the
discussion of cash, not simple sayings that bounce back and forth
in response to the mood of the market. Individual investors should
not be afraid to hold cash, even when it's earning little, if it's
available to them when needed most. And investment professionals
should get away from misguided notions about how much cash is too
much cash in a portfolio. Let the manager use the value and power
of cash to execute a strategy. Then you can judge whether the
strategy makes sense. Don't remove cash as an effective weapon.
Please note that the content of this site should not be construed
as investment advice, nor do the opinions expressed necessarily
reflect the views of CFA Institute.
3 Reasons Not To Flee Dividend Stocks