CASH IS KING -- AND A HARBINGER OF DOOM? / BARRON´S MAGAZINE

Cash Is King—and a Harbinger of Doom?

By Lewis Braham   


Photo: Getty Images


Stephen Yacktman is still officially on a stock-buying strike. “We’ve been willing before to go down with the ship and say, ‘We’re not going to invest your money,’ ” the co-manager of the AMG Yacktman fund says. “If you don’t like it, sell the fund. We’re willing to be fired.”


Today, Yacktman’s $8.5 billion fund (ticker: YACKX) has more than 25% of its assets in cash, and even after the market’s recent slide, he hasn’t been buying. “When you look at valuations today, to go back to a normal valuation the market would have to fall by more than half,” he says. Some investors have indeed fired him for refusing to budge. The fund has experienced $1.2 billion in outflows in the past year as its 13.2% return in that period has trailed the market by 3.5 percentage points, and its fully invested peers, by 1.9 points.




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Yacktman didn’t anticipate this month’s correction. Nor does he much care how the market overall performs: “We don’t hold the cash because it’s a risk-mitigation tool.” Rather, he’s one of a dying breed of active managers who hold cash as part of their valuation discipline. Managers used to hold cash to handle redemptions, but now they can use exchange-traded funds as a liquidity tool—making the decision to hold cash more about investing strategy than fund administration, says Russel Kinnel, Morningstar’s director of manager research. “A small-cap fund can buy a small-cap ETF; the ETF is still liquid [and can be sold to meet redemptions], but you’re not lagging the market,” he says.

Trailing the market is a bigger concern in an environment where investors are increasingly shifting to low-cost index funds and managers face “career risk”—Wall Street’s euphemism for getting fired. So managers herd into stocks even when they think they’re overvalued. According to Morningstar, in 1997 the average U.S. stock mutual fund held 5.4% cash. That dropped to 3.5% at the end of 2007—right before the last crash—and fell further to 2.4% at the end of 2017.

Some old-school money managers care nothing about career risk. “The view of risk of dinosaurs like me is that risk is about business risk or valuation risk or the risk of putting your money with people who are not good stewards,” says Joel Tillinghast, manager of the $41 billion Fidelity Low-Priced Stock fund (FLPSX).

Tillinghast’s fund is one of the few to often hold significant amounts of cash, yet it has still beaten its mid-cap benchmark and its peers over the past one-, three-, five-, and 10-year periods. Its cash levels were 11.4% of its portfolio at the end of October, according to Morningstar, although that has fallen to slightly below 10%, Tillinghast says.

Of 2,258 diversified U.S. equity funds, only 111 have 10% or more in cash—and their recent performance has been poor. Just 18% of those with five-year records have beaten their peers as of Feb. 10. Go back 15 years to include the 2008 crash, and the outperformance number jumps to 48%.

COULD WE BE REACHING A POINT when cash won’t be trash again? Rarely will a money manager admit they’re timing the next market crash, but Kinnel says there’s an implicit market call when managers start to build cash because they can’t find any investment opportunities. In the week ended Feb. 10, when the Standard & Poor’s 500 index fell 5.2%, 78% of these cash-heavy funds beat their peers.  
Tillinghast is actually more bearish on U.S. stocks than his current cash position indicates. He has a 38% position overseas, where he says valuations are more attractive, most notably 10% in small Japanese stocks. “Japan is earlier in its up cycle,” he says. Meanwhile, little looks cheap at home: “The average price/earnings ratio for the cheapest 20% of stocks in the U.S. market today is about 18. That’s higher than the cheapest 20% during the growth stock bubble of 1999 and 2000. That’s deeply frustrating.”




Still, Tillinghast was willing to cross the picket line and buy some stocks during the February correction. “I wouldn’t say we loaded up the truck, but we packed the minivan in the last few days,” he says. “We bought a couple of financial and energy company stocks. Retail is another area where we are finding some attractive stocks, but you seriously have to pick over every company because some of them are going to be killed by Amazon.com [AMZN].” Retailers Ross Stores (ROST) and Best Buy (BBY) were the second- and third-largest positions in the fund as of the end of December.

Despite beating its peers, Fidelity Low-Priced Stock has suffered $6.2 billion in outflows in the past 12 months, according to Morningstar. Tillinghast acknowledges that the cash is useful for meeting redemptions, although he would be open to using an ETF substitute if market conditions were right. “It makes sense if you think the index an ETF tracks is undervalued,” he says. “I think the stocks I have actually chosen are more undervalued than the index.”

Not every manager with cash is value-oriented. “We have high-beta stocks in the portfolio,” says Hans Utsch, manager of the $5.8 billion Federated Kaufmann fund (KAUAX), which had a 14% cash position at the end of 2017, yet has beaten 95% of its peers in the past five years. High-beta stocks are those that move up and down more than the market. “I figure we’re neutral with the market, with about 15% cash.” Still, Utsch argues, “we’re again in bubble territory.” Cash is his way of being prepared for when the bubble inevitably pops.