Wednesday, February 15, 2012


"It is expensive to sit on cash."

"I gave you my money to invest in the markets, not to sit on it and do nothing with it."

Yes, investors dish out plenty of advice to 'professional' money managers. If the 'professional' does not oblige, the investor takes her money back and gives it to a 'professional' who will oblige and invest every last cent in stocks right away. If this is the case, we would advise the investor to keep her money and just buy an index fund, saving herself the fees and expenses associated with 'active' and 'professional' money management. This is because being fully invested makes sense only when Mr. Market is throwing fat pitches at us - we define a fat pitch as a company which is trading at a significant discount to its intrinsic value. This is when you want to go all out and swing confidently. Otherwise, you need to keep cash on hand to take advantage of the fat pitches when they are thrown sometime in the future. If you were planning to buy and own a private business, would you buy it when sellers are demanding a premium for their businesses or would you wait until you find a distressed seller who must sell his business at a price you perceive to be attractive?

If an investor trusts her risk capital to an asset manager, then presumably she has assessed the opportunity cost of parting with this capital for a reasonable period of time. There is no sense in coercing the manager into taking undue risk because you don't want the manager to 'just sit on cash'. The manager's task is to provide the investor with reasonable absolute returns over an entire business cycle. If the investor does not have the patience for this and has better uses for her cash, then by all means she should have never parted with it to begin with.

In the end, the asset manager's job is to own high quality businesses which will prosper over time, resulting in higher stock prices which will therefore increase the purchasing power of our hypothetical investor. The magic is to buy these businesses at attractive valuations and with plenty of margin of safety. This is possible only if the manager has had the foresight to hold onto cash, waiting for opportunities when volatile markets cause the valuation of securities to decline below their long-term intrinsic value. No cash, no possibility of taking advantage of Mr. Market's gyrations.

We recently watched an interview with Matthew McLennan, the portfolio manager of First Eagle Funds (of Jean-Marie Eveillard fame), who eloquently articulated the need to maintain cash on hand when constructing a portfolio of stocks. Mr. McLennan notes that markets are like stormy waters and investing is analogous to sailing a ship through the choppy waters without getting thrown overboard. It is the cash on hand which provides the ballast the ship needs to avoid disaster as Mr. Market's mood fluctuates from giddy to fearful. Without that ballast, the investor would never have the chance to take advantage of the fat pitches.

Do not be afraid to hold onto cash in your portfolio. But also do not be afraid to be greedy when others are fearful. These days investing in the bluest of blue chip global companies will enrich you with highly attractive dividend yields (much better than locking your capital in 10 Yr Treasuries for a meager 2%) while providing you with the opportunity to participate in the future growth of these wonderful enterprises. Intel (NASDAQ: INTC), General Electric (NYSE: GE) and Coca Cola (NYSE: KO) are a few names that come to mind. Happy sailing.


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