The Value of Cash

In last week’s Fall Update, I mentioned the current levels of cash and short Treasuries in our portfolios, citing Warren Buffett’s position on cash according to his biographer:

“He thinks of cash differently than conventional investors,” Ms. Schroeder says. “This is one of the most important things I learned from him: the optionality of cash. He thinks of cash as a call option with no expiration date, an option on every asset class, with no strike price.” It is a pretty fundamental insight. Because once an investor looks at cash as an option – in essence, the price of being able to scoop up a bargain when it becomes available – it is less tempting to be bothered by the fact that in the short term, it earns almost nothing. (http://www.businessinsider.com/cash-as-a-call-option-2012-9)

In other words, according to Mark Yusko, “cash has protective and option value, keeping portfolios safe during dislocations and providing liquidity to buy bargains with high margins of safety after the corrections occur.” (http://www.morgancreekcap.com/documents/MCCM%202Q2016_Market%20Outlookv2.pdf)

Mark’s 66-page quarterly letter linked above (worth the read despite being the length of a small book) is loaded with insights from Seth Klarman, a legendary value investor. A number of years ago, I was able to get my hands on a copy of Seth’s out-of-print book Margin of Safety — which was one of the key influences that led to our risk-focused investment approach at Precedent Asset Management.

In the process of building incredible wealth for his clients, Seth Klarman’s firm routinely holds 30% to 50% of their portfolios in cash — in complete contrast to the notion that a good manager should be fully invested at all times. In a letter last year, a retiring partner at the firm stated,

“One of the most common misconceptions regarding Baupost is that most outsiders think we have generated good risk-adjusted returns despite holding cash. Most insiders, on the other hand, believe we have generated those returns BECAUSE of the cash. Without that cash, it would be impossible to deploy capital when we enter a tide market and great opportunities become widespread.”

Today, cash is easily the most hated asset class, evidenced in numerous ways according to a recent article from Jesse Felder. One of the most telling is investors’ current willingness to own bonds at a negative rate of return. It is unfathomable to me why any investor would want to own an asset with a negative yield and additional exposure to risk when cash exists as a viable alternative for patient investors.

Cash and a little patience will go a long way in today’s market environment. It might be a little lonely, but it’s hard to feel too lonely when you’re sitting at the table with Warren, Seth, Mark and Jesse.