[This article was first published in the Financial Post on]

For almost 11 years, from the bottom of the market in 2009, to a few weeks ago, cash had come to be regarded as a burden to equity investors. More crudely put, cash was “trash.”

Overall, performance for all U.S. domestic funds over the last 10 years (to June 30, 2019) has been disastrous with almost 88 per cent of them underperforming their benchmarks. And if a fund was sitting in cash, which has earned investors very low rates of returns for years, this only added to the performance deficit. Simply put, it’s been like a ball and chain on the legs of portfolio managers’ performance who have refused to deploy it into overpriced stocks.

Until February, holding cash in an equity portfolio during the long bull run from March 2009 has been regarded by most investors as unacceptable. With what appeared to be unending rising stock prices over the last 11 years, why would a money manager or investment client want to penalize themselves by holding an asset that produced virtually nothing in returns?

Well, over the past decade, they’ve been right. But they aren’t any more.

The case against cash held in equity portfolios has a number of origins. First, there are those investors who say they hold funds to get maximum exposure to equity investments. They proclaim that it’s their job to determine cash levels, not the PMs. However, a deeper examination reveals that to be fully invested in equities at all times puts undue pressure on equity portfolio managers to invest, regardless of prices to be paid or quality of businesses. Managers in this position basically have a gun at their heads, with their clients yelling, “Buy!” How can this be in the clients’ best long-term interests?

Another basis of the “fully invested” stance comes from the investment companies and portfolio managers themselves. In the extremely competitive world of shorter-term measurements, they are pressured to focus more on short-term results. Managers feel they can’t afford to miss out on returns in a bull market, even for a quarter, much less several years, by holding onto non-performing cash. To do so can cost the fund companies in terms of asset redemptions and for the portfolio manager, his or her job.

And let’s not forget the rise of equity index fund assets, which total some US$4.6 trillion while total index fund assets have surpassed US$6 trillion, much of which has been added since 2009.

It is my belief that a substantial percentage of investors in these index products have no memory of the Great Financial Disaster of 2007-08 that almost took the entire economy down. Further, I don’t think it is a stretch to say that most investors today don’t remember the dot-com bubble, which burst 20 years ago.

All that many investors know from March 2009 onwards are rising stock prices, which perhaps explains their reluctance to embrace cash, an asset that gives investors two great advantages.

First, it affords protection against general market declines such as the one we recently experienced. Secondly, cash gives the stockholder a potent buying arsenal when great companies appear at bargain prices.

The investors at Southeastern Asset Management, a well-known investment firm, sum up another key advantage of holding cash.

“We hold cash only at points when we cannot find equities that meet our strict investment criteria,” the firm said in a 2014 report titled The Benefits of Periodic Cash in Equity Portfolios. “We have found that a low return on cash for limited periods is dwarfed by the return opportunity from the next deeply discounted qualifying investment we buy. With cash on hand, we are positioned to be a liquidity provider and can immediately purchase stocks at what we believe to be advantageous points without being forced to sell holdings at unfavourable valuations.”

Why else has Warren Buffett, until recently, been sitting on US$128 billion of cash? Or Sam Zell, the real estate genius, building up over US$25 per share in cash while his stock trades at a small premium of US$32? Both these world-class investors have obviously been aware of the expensive nature of the markets they participate in. In fact, at its height in February, valuations reached levels in excess of what they were in 1929, preceding the Great Crash and depression that followed.

As the coronavirus spreads and whole industries in both the service and manufacturing industries are grinding to a halt, that hated cash pile goes instantly from “trash” to “treasure.” We highly recommend you give it serious consideration during the next market cycle.

As Buffett’s partner, Charlie Munger, put it in his book Poor Charlie’s Almanack: “It takes character to sit with all that cash and do nothing. I didn’t get to where I am by going after mediocre opportunities.”

Larry Sarbit is a portfolio manager at Value Partners Investments in Winnipeg. He can be reached at [email protected]

This article was first published in the Financial Post on April 20, 2020