Individual investors have been cutting back on cash in portfolios, the exact reverse of what Warren Buffett has been doing at Berkshire Hathaway.
Who do you think has got it right?
Cash at Berkshire Hathaway stood at just over US$55 billion as of June 30, an all-time high and two-and-a-half times the level he has said in the past he likes to keep on tap to meet extraordinary claims at his insurance businesses. That’s also up more than 50 per cent from a year ago.
Mr Buffett’s green pile is in sharp contrast to individual American investors, who have cut cash in portfolios to 15.8 per cent, a 14-year low, according to the July asset allocation survey from the American Association of Individual Investors.
To be sure, businesses and individuals hold cash for different reasons, but Mr Buffett has used Berkshire, in part, as an investment vehicle through which we can interpret his views on markets, or at least the prices of some assets in them.
Berkshire, of course, has some difficulties in putting cash to work not faced by your average dentist or lawyer, in that it tends to make very large investments and as such may need to be more patient than smaller fry. So it is quite possible Berkshire Hathaway is waiting for the right acquisition to come along.
It is also similarly possible that Mr Buffett is not happy with the prices, and is biding his time against a day when prices have been marked down. One thing not influencing Berkshire is tax policy, as all of its cash is generated in the US, meaning it not among the legion of corporations holding money offshore to avoid a repatriation tax.
The bottom line is that the best investor in the world is going in the opposite direction to a class of people often reputed to be among the worst.
Cash returns are, as we know, lousy; the little that one can get in liquid instruments inevitably being lower than the toll extracted by inflation. And indeed the long-term returns on cash are terrible, lagging behind every asset class and investment strategy this side of setting money on fire.
Still, looking at the long-term returns on cash and concluding it is a tool to be shunned is a bit like saying a golfer ought not to have a back swing because only forward momentum drives the ball. Cash is the thing which puts you in a position to drive the ball and gives your investment swing power. Its value lies not so much in itself but in the ease with which it can be turned into other things.
Cash is worth holding because it is dry powder which gives the owner options. That optionality varies, of course, based on your view of how richly valued assets are, but it is always there.
Cash also provides investors with what so many hedge funds and other expensive financial products claim to provide: protection against the downside. James Montier, of the fund managers GMO, calls cash “perhaps the oldest, easiest and most underrated source of tail risk protection”. If you are worried, as small investors seem not to be, about the small possibility of large impact events, then cash has a value not expressed by its yield.
Mr Montier also argued, in a 2011 paper, that cash provides decent protection against both inflation and deflation, citing the experience of the US inflation of the 1970s and Japan since 1990. During the ‘70s cash was a bit worse than equities as inflation soared, but a bit better than bonds. In Japan, in contrast, cash did much worse than bonds, but, as goods and services declined in price, did far better than stocks.
But really if cash has something to recommend it in the current environment, it is its optionality in a time of uncertainty. The odd thing about the current market is how calm it is.
We’ve never before been through a lift-off from zero rates or a running down of a massive Federal Reserve balance sheet. Likewise, we’ve never run into a recession while also being at the zero lower bound for interest rates.
Any of the above is possible in the next 12 to 24 months, and yet markets aren’t even close to pricing these risks.
While it may never happen, Mr Buffett is arguably better positioned with his cash roll if it does than the small investors who are nearly as heavily invested as they have been this millennium.
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