(James Saft is a Reuters columnist. The opinions expressed are
By James Saft
Aug 20 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 $55
billion as of June 30, an all-time high and two and a half times
the level he's in the past said he likes to keep on tap to meet
extraordinary claims at his insurance businesses. That's also up
more than 50 percent from a year ago.
Buffett's green pile is in sharp contrast to individual
investors, who've cut cash in portfolios to 15.8 percent, 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 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 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 U.S., making
it not one of the legion of corporations holding money offshore
to avoid a repatriation tax.
Bottom line though is that the best investor in the world is
going in exactly the opposite direction to a class of people
often reputed to be among the worst.
THE DISCREET CHARM OF CASH
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
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 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.
Montier also argued, in a 2011 paper, that cash provides
decent protection against both inflation and deflation, citing
the experience of the U.S. 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, 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 in the face of fairly unprecedented conditions.
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, and we might want to cheer up,
Buffett is arguably better positioned with his cash roll if it
does than the small investors who are nearly as heavily invested
as they've been this millennium.
(At the time of publication James Saft did not own any direct
investments in securities mentioned in this article. He may be
an owner indirectly as an investor in a fund. You can email him
at firstname.lastname@example.org and find more columns at blogs.reuters.com/james-saft)
(Editing by James Dalgleish)