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 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 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 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.
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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
jamessaft@jamessaft.com and find more columns at http://blogs.reuters.com/james-saft)
(James Saft is a Reuters columnist. The opinions expressed are his
own)
(Editing by James Dalgleish)
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