BULLS & BEARS: Using investors' cash well belies parking-it theories

May 23, 2005

When it comes to four-letter words, "cash" is perhaps the most despised in the investment business. Investors are regularly counseled to "remain fully invested at all times." There even is an industry adage that "cash is trash."

The primary case against holding cash rolls off the tip of advisers' tongues like a Buddhist chant: "You can't time the market." Industry marketing pieces show that if you were out of the stock market on its best-performing days over the years, your investment returns are significantly diminished.

The argument that no one can consistently time entry and exit from the market with long-term success is valid. As evidence, consider that not a single markettimer is listed among Forbes' 400 wealthiest people.

However, there are occasions when it might be wise for an investor to hold a larger than normal amount of cash as a temporary parking place. In fact, that is exactly what a handful of well-respected money managers are doing right now.

Why are some managers holding as much as 30 percent of their portfolios in cash? It is not because any of them are predicting an imminent market meltdown, although they do acknowledge there are plenty of risk factors lurking in the global economy. Instead, the reason given is that the current business valuations in the stock market are not cheap enough to entice them to make long-term investments.

In a 1974 Forbes article, Warren Buffett used a baseball analogy in this quote: "Investing is the greatest business in the world because you never have to swing. Nobody calls a strike on you, so you wait for a pitch you like, then, when the fielders are asleep, you step up and hit it."

Buffett notes this method is opposed to institutional investors who are subject to short-term performance pressure and, "where a jeering crowd is yelling, 'Swing, you bum!' when the pitcher is trying to pitch him an intentional walk."

Most mutual funds operate under a mandate of being fully invested. The risk to a fund manager of being out of sync with the market or peer funds over any quarterly period may cause investors to pull money out or may even cost a fund manager his or her job.

Speculators often confuse active buying and selling with solid investment decisions. This is where the individual long-term investor has an advantage; when the market is "throwing you balls," you don't have to swing.

These patient investors admit it is a grueling experience to stray from the herd and remain steadfast in their discipline. Respected fund manager Jean-Marie Eveillard once made the comment, "I would rather lose half our shareholders ... than lose half of our shareholders' money."

When an investor is unable to find anything intelligent to do, holding cash reserves offers several benefits. It offers positive, albeit limited, yield, safety of principal and instant liquidity. Then, when an attractive investment presents itself, the investor is prepared to act.

As Berkshire Hathaway's Charlie Munger has said, "You have to understand the odds and have the discipline to bet only when the odds are in your favor."



Ken Skarbeck is managing partner of Indianapolisbased Aldebaran Capital LLC, a money-management firm. Views expressed are his own. He can be reached at 818-7827 or ken@aldebarancapital.com.
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