The Once And Future King

Dan Ferris - Wed 30 Jun, 2004

"...This asset is the ultimate contrarian play. Nobody in the Western world wants to hold it, yet its such a prudent investment. And from today, the US government will pay you 25% more dollars for holding it...probably..."

Quick - what’s the most undervalued investment right now?

What’s the one asset you wouldn’t even think of holding?

I’ll give you a hint: According to the Investment Company Institute of America, this asset represented 77.1% of all mutual fund assets in 1981...

Gold was popular back then. But if you said gold, you’re wrong. Like gold, people buy this asset when they’re scared, like they were in 1981.

In 1999, this unloved asset fell to an all-time low of 23.7% of all mutual fund assets. Investors hold as little as possible of it when they’re very optimistic, like they were in 1999.

Today, 27.7% of all US mutual fund assets are in this safe, liquid instrument. In historical terms, that seems pretty optimistic.

Perhaps by now you’ve guessed that the answer to these questions, the most unwanted asset today, the one thing nobody seems to want to own, the one asset people can’t seem to get rid of fast enough, is...

Cash. The statistics I quoted above are the amount of total mutual fund assets invested in US money market funds - funds that invest all their customers’ money in the most liquid short-term securities, like 13-week T-bills, which is how corporations and large investors hold cash.

I’m about to tell you that you should be holding plenty of cash, and I can explain it in, what I believe to be, the most compelling of terms...

The simple explanation is that every investor who really knows what he’s doing is holding a large cash position right now. By “every investor who really knows what he’s doing,” I’m referring to some of the greatest investment minds of our time. Warren Buffett, Staley Cates & Mason Hawkins, Jim Gipson, Tweedy Browne, the Sequoia Fund and Alan van den Berg.

Warren Buffett has made more money investing than anyone else on the planet. According to his most recent balance sheet, Buffett is holding $34.68 billion in cash. That’s equal to about 25% of the $138 billion market cap of his Berkshire Hathaway empire. Berkshire Hathaway stock is selling for around $89,750 per share, and he’s holding $22,521 per share in cash. Subtract the cash, and Berkshire Hathaway is selling for slightly under 13 times GAAP earnings. Not quite extreme value, but it’s interesting that the market thinks the greatest investor of all time isn’t worth as much as the S&P 500, at about 16.4 times GAAP earnings (and almost certainly a higher multiple of earnings in reality).

Staley Cates and Mason Hawkins are the co-managers of the Longleaf Partners Fund, which we added to our portfolio in February. Longleaf Partners Fund’s cash position is now at about 25% of assets. I asked Staley Cates about this. The exchange went as follows:

Ferris: What on earth do you do when there’s nothing to buy? Do you just sit and wait? All the value investors are holding lots of cash.

Cates: Yes, we just sit and wait. That’s often very hard to do, and we’re not too pumped about earning pretax money market yields. But we’ve made the alternative mistake (i.e. forcing something) enough to not do it again.

Longleaf Partners Fund’s largest equity position is Vivendi, at 6% of assets. Cash is at 25%, a little more than four times that amount.

At the Clipper Fund’s annual meeting in March, lead manager Jim Gipson explained why the fund is holding 34% of its assets in cash and short-term securities. “The Federal Reserve, with its fed funds’ rate of 1%, has made it extremely difficult, even painful, to hold short-term funds. For example, at this rate, your money market fund will double every 140 years...this is not a good time to be invested in long-term assets now...and for that reason, we’ve pulled back and increased the most contrarian and uncomfortable asset possible - which is short-term cash.” Gipson has a strategy about maximising his cash yields.

Tweedy Browne likes using repurchase agreements for short-term cash. It has 0.3% in US T-bills and 16.3% of its Global Value Fund in repurchase agreements, or repos.

The Sequoia Fund is run by former pupils of Ben Graham, and was recommended by Warren Buffett. They’ve got 35% of their money in Berkshire Hathaway, their largest position. The rest of the Sequoia Fund’s assets are in just 13 stocks. Sequoia reported holding 14.41% cash at yearend 2003. Sequoia is the most highly concentrated fund I know of, and its largest holding (Berkshire) holds 25% of it market cap in cash, and its second largest holding is cash itself. That comes out to about 23% of Sequoia Fund assets in cash. (.25 X 35% + 14.41% = 23%.) Sequoia has turned every $1 invested with it in 1970 into $151 dollars today.

Alan Van Den Berg of Century Management has earned his clients a hair under 130-times their money since 1974. He agrees with the cash holders. A few months ago, Van Den Berg told his clients that, “Today, I’d say that, once again, you’re better off being in a money market fund. Even if you’re only getting three-quarters of 1% on your money, if the economy recovers, interest rates are going to go back up. Short-term rates will rise 3-5%. So you’re not going to be at 1% forever...the most hated investment today is cash. Everybody hates cash. Nobody can stand to be in cash. By contrast, everybody just loves being in stocks. At the bottom of this bull market - back when it began - 50% [sic] of US mutual funds were money market funds.”

It’s one thing to wind up in cash because you’ve sold stocks, which is how Jim Gipson characterises his large cash position. He’s simply found more US stocks to sell than to buy. But Van Den Berg’s advice is of a different character. Van Den Berg says you’re better off in a money market fund than anywhere else. Money market rates, puny as they are, outperformed the S&P 500 in the last five calendar years. In fact, the S&P 500 actually lost money during that time. All of the above is why yours truly has approximately 84% of his liquid assets in cash, and the rest in stocks.

Echoing Van Den Berg’s comments, contrarian money manager David Dreman writes in his latest annual shareholders letter, “Anybody can own what they like. The challenge is to own what you hate.” I couldn’t agree more. I recommend that you take Dreman’s challenge, sell overvalued stocks and bonds you may be holding, and make cash - the most hated asset today - your largest holding.

If a consensus among these investors makes you wonder if the idea of holding cash is about to become a bad one, take heart: There are at least two dissident fund managers among the great value investors of our time. The first is the duo of Bill Nygren and Henry Berghoef at the Oakmark Funds. They’re only holding about 3.8% of their assets in T-bills and another 2.1% in other highly liquid short-term US government agency securities, for a total of 5.9% in cash. Nygren and Berghoef’s largest position is in a bank, Washington Mutual (WM), which makes up 17% of the Select Fund’s assets.

Bill Miller is even more fully invested than Oakmark. Miller is the manager of the Legg Mason Value Trust. At the end of 2003, he became the only investment manager ever to beat the S&P 500 index 13 years in a row. So we have good reason to call him the best stock picker of the last 13 years. Miller finds value in franchises and market leading brand names, even if it means buying Amazon.com and eBay. Miller’s most recently published shareholder report says he’s got 98.9% of his money in stocks, and just 1.1% in cash.

At 16.4 times earnings, the S&P 500 is near its historical mean valuation of 16 times earnings. It’s been above that level most of the time since 1995. If you’re going to buy stocks, you still need to be careful, and buy only what is safe and cheap enough. No matter what you’re doing with your money right now, be aware that cash is king; make sure you have more cash than anything else.


Regards,

Dan Ferris
for The Daily Reckoning