John Neff: How Investors Should Think About Holding Cash

Johnny HopkinsJohn NeffLeave a Comment

In his latest article at Akre Capital titled – How We Think About Cash, John Neff discusses how investors should think about holding cash. Here’s an excerpt from the article:

Cash is a controversial subject among many fund investors and fund managers. Some fund managers wish to periodically hold or accumulate cash in anticipation of better investment opportunities in the future. However, many fund investors believe that equity mutual funds should operate at all times with as little cash as possible. Typical reasons cited by fund investors for their “minimal cash” worldview include:

  • cash earns virtually nothing; and
  • investors use funds for equity exposure and want that equity exposure maximized while leaving the broader cash weighting decision to them.

Such investor imperatives, combined with pressure to outperform the broad market at all times, have predictably led to a general reluctance among equity funds to hold much cash. Among the largest 200 US Large Cap Growth funds, the average cash weighting at present is approximately 1.5%, according to Morningstar.

These concerns about cash range from factual (cash indeed earns virtually nothing) to understandable. Cash is not an asset that holds, let alone increases, purchasing power over the long term. We get it! However, we have a distinctly positive take on the role and importance of cash and believe that fund investors can be well served by its disciplined use.

The Value of Cash

To us, the value of cash has very little, if anything, to do with the return one earns on it directly. Rather, the investment value of cash is fortitude. In a bear market, cash is the “thin green line” that separates crisis from opportunity. This view is expressed well by Morgan Housel in his book The Psychology of Money:

No one wants to hold cash during a bull market. They want to own assets that go up a lot. You look and feel conservative holding cash during a bull market, because you become acutely aware of how much return you’re giving up by not owning the good stuff.

But if that cash prevents you from having to sell your stocks during a bear market, the actual return you earned on that cash is not 1% a year–it could be many multiples of that, because preventing one desperate, ill-timed stock sale can do more for your lifetime returns than picking dozens of big-time winners.

In other words, the value of cash is not the return it provides but the behavior it promotes. Because long-term investment success has more to do with behavior than just about anything else, we believe investors that are willing to hold or accumulate cash when valuations are frothy are more likely to behave better during tough times when opportunities abound. By “behave better,” we mean sell less and/or buy more.

In Conclusion

We prefer to invest cash opportunistically, not routinely, and to do so in accordance with our valuation discipline and not arbitrarily to minimize cash. Cash does not burn a hole in our pocket in the absence of opportunity. In short, we do not look at cash levels to determine whether to buy stocks; we look at stocks to determine whether to invest cash.

Our views on the role and value of cash may not be widely shared. Given the importance of the subject to our investment process, we thought that ample reason to provide a better understanding of how we think about cash.

You can read the entire article here:

John Neff: How We Think About Cash

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