Should fund managers let cash build or stay fully invested at all times?
With both stock and bond prices up sharply since the beginning of last year, legendary value investors Jean-Marie Eveillard and Charles de Vaulx are hard-pressed to come up with investment ideas they consider both appealing and reasonably priced. At the same time, the long time co-managers of First Eagle Global and First Eagle Overseas funds find that a surge of inflows has made it difficult for them to invest in small- and mid-cap names without influencing the price of those stocks, says de Vaulx.
A richness of shareholder inflows and a dearth of solid investment opportunities prompted the firm to close First Eagle Overseas to new investors in January. At the end of the first quarter, First Eagle Global and First Eagle Overseas had 22% of assets and 20% of assets, respectively, in cash equivalents such as commercial paper. With U.S. markets even more richly valued than those overseas, First Eagle U.S. Value Fund had 25% of its assets there. "We will only buy securities at prices we like," says de Vaulx. "And when we can't find them, we will let cash build."
Eveillard and de Vaulx are by no means alone in the movement by investment managers into short-term commercial paper, Treasury bills and other money market havens. Statistics compiled for Financial Advisor by Morningstar show that 157 equity and asset allocation funds have more than 20% of their assets in, cash according to the latest holdings figures available in early April. The group includes some of the industry's most well known and respected names, including First Pacific Advisor's Robert Rodriguez, James Gipson of Clipper Fund, Jerome Dodson of Parnassus Fund, David Winters of Mutual Shares, Bonnie Smith and Fred Green of the Merger Fund, Wally Weitz of Weitz Value, and Richard Pell and Rudolph Riad-Younes of Julius Baer International Equity.
Even famed investor Warren Buffet has joined the cash club. At the end of 2003, Berkshire Hathaway had 22% of its total investments, representing some $31 billion, sitting in short-term U.S. Treasury securities such as bills and repos. In a recent article titled "Why Legendary Investors Are Drowning In Cash," Morningstar analyst Gregg Wolper notes the trend, and comments that "... it's remarkable how many top-flight managers currently have more than 20% of assets in cash and say they find compelling opportunities scarce to nonexistent."
A Fully Invested Stance
Perhaps even more remarkable is the fact that the group represents only a small fraction of the mutual funds available, and that the vast majority of funds remain fully invested at all times. While the typical fund may have some cash on hand to meet redemptions, the average equity fund has only 4.92 % of its assets there.
The fully invested policy represents a shift in thinking from before 1990, when fund managers often regarded their job description as two-fold: selecting securities and deciding whether or not it was a good time to commit money to the stock market. For many of them, the allocation end of those responsibilities came to a halt when some cash-heavy funds fell behind their competitors and benchmarks as the stock market started to surge. At the same time the increasing attention to asset allocation, particularly among financial advisors, called into question the utility of funds whose moves into cash threw asset allocation plans out of whack.
Many financial advisors applaud the mandate to keep mutual fund assets in play at all times, and believe strongly that the decision to shift among different asset classes should be left to them. "It stinks when funds move large amounts of assets into cash," says Roy Diliberto of RTD Financial Advisors in Philadelphia. "If we want cash in a portfolio, we will make that decision."
Diliberto recalls a conversation with the famously acerbic manager of a small-cap value fund who had moved 60% of the fund into cash. When he called him to question the oversized allocation, the manager explained that there was nothing he wanted to buy at that point. "I asked him why, if that is the case, he didn't lower his management fee," recalls Diliberto. "Why should I pay someone a management fee of 1% or more just to hold on to my money?"
Rick Ferri, an advisor with Portfolio Solutions in Troy, Mich., agrees that funds should stay fully invested at all times. "We won't buy funds where the manager has the ability to move into cash," he says. "That decision should be left to us."
But de Vaulx and others contend that the mutual fund industry has taken the fully invested mandate too far. "I believe it is criminal for any fund manager to have to hang on to securities just to stay fully invested," he says. "We must exercise fiduciary duty, and part of that duty is to decide whether or not stock prices make sense."