Grab that cash with both hands
and make a stash"
I'll admit it, I've always been a fan of cash. Cold, hard cash. Not that I carry huge wads around, but I want to know that I can get my hands on it at a moments notice.
Back in 1970, after Warren Buffett's grandfather passed, Warren found an envelope in his safety deposit box along with $1,000 in cash. The letter extolled the virtues of ready cash, explaining, "Over a period of a good many years I have known a great many people who at some time or another have suffered in various ways simply because they did not have ready cash. I have known people who have had to sacrifice some of their holdings in order to have money that was necessary at the time. Thus I feel that everyone should have a reserve. It is my wish that you keep this envelope in your safety deposit box, and keep it for the purpose it was created for."
Ever the vigilant student, Warren Buffett listened to Ernest Buffett's advice, and has kept substantial reserves in cash. He likes to keep at least $20 billion of Berkshire Hathaway's assets in liquid cash equivalents. Cash plays three vital roles in an individuals portfolio; 1) as a risk management tool, it helps mitigate the downside, 2) as an opportunistic tool, it's nice to have ready cash when an opportunity presents itself, and 3) as a liquidity management tool, having cash available for distribution needs.
Remember back in 2008 when the financial markets were in a death spiral, Warren Buffett was able to sit back and choose who he wanted to bail out and set the terms. He was able to extract a sweetheart deal from Goldman Sachs whereby Berkshire purchased $5 billion of preferred shares in Goldman paying a 10% dividend, and also received warrants to buy $5 billion in common stock at $115 per share. Berkshires portfolio was protected on the downside, and was subsequently able to take advantage of opportunities when they presented themselves.
Warren's Berkshire Hathaway is not alone in its fondness for cash. Even with cash holdings generating negative real returns, US Industrial companies have increased their cash reserves from $600 billion in 2007 to more than $1 trillion today. What 2008, and the ongoing financial turmoil, has taught corporate America is that you can't rely on the capital markets to be there when you need them. Companies, and individuals, need to be ready to fund themselves.
How much cash is enough? Clearly $1,000 tucked away in a safety deposit box won't get you very far in today's dollars. A safe starting point is to have at least one years worth of expenses covered. This is more than most pundits tell you to put away, but that's generally because they're trying to sell you something. Once you've set aside a years worth of expenses you can then begin thinking of how to use cash in your asset allocation process.
At Rockhaven, cash in our global tactical asset allocation model will vary between 0% and 60%. This percentage will vary based on our global macro-risk outlook. The cash allocation is determined by how attractive every other asset class looks on a technical and fundamental basis. We're not making an active cash call, cash is a default asset. Lets take US Equities as an example. Our allocation to US stocks can vary between 7% and 25%, we are currently at a neutral 15%. As our allocation to stocks increases or decreases, our allocation to cash moves in the opposite direction.
Our current allocation to cash is at 40%.
The Feds zero interest rate policy (ZIRP), makes holding cash a bit painful at times, but it also has its advantages. As stated above, holding cash helps protect us on the downside (we sleep better), and it allows us to be ready to move whenever an asset becomes extremely oversold. Of course cash isn't risk-less, everything carries risk. We have to worry about inflation risk, credit risk, and liquidity risk, but these are all risks we'd deal with no matter what. However, cash can be a great asset, or as Roger Waters said, "Money it's a hit. Don't give me that do goody good bullshit."
Be careful out there, and keep the lights on,
Chris Wiles, CFA
412-260-7917
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This article contains the current opinions of the author but not necessarily those of the Rockhaven Capital Management. The author’s opinions are subject to change without notice. This article is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein are based upon proprietary research and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.
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