The Forager International Shares Fund’s cash balance has fallen to below 3% from about 13% at the end of December 2015, its lowest level since inception. This made me ponder the role of cash in a fund like ours.
Many investors like having some cash, or ‘dry powder’, in their portfolio to take advantage of opportunities that may suddenly arise. Market corrections occur unexpectedly and being fully invested can restrict investors’ ability to snap up assets at bargain prices. Some like to keep a minimum allocation to cash, say 10%, at all times.
To a value investor this makes perfect sense – you don’t want to be short of cash at a time when Mr Market is most likely to offer you the best deals. Yet this is one value investing credo I feel differently about. Let me explain.
We are not market timers but stock pickers. Clients pay us to find cheap stocks across the globe and I believe we should be invested 100% of the time in our good ideas. If a market correction comes and superior opportunities arise, we should be prepared to sell cheap stocks to buy even cheaper ones.
What if we don’t have enough good investment ideas? Should we go for our second best ones? I don’t think so. As Seth Klarman puts it “Where does it say that investing means always buying something, even the best of a bad lot?”.
What I am suggesting is that the Fund’s cash balance should reflect the level of attractiveness of the investment opportunities available to us at a given point in time. And not a prescriptive or target level cash weighting. And definitely not a minimum. If we have the ideas, we should be fully invested. If we don’t, we shouldn’t.
Since we launched the International Fund in February 2013 we have experienced a raging bull market. Low interest rates forced many investors to lower their required rates of return, pushing stock prices higher and higher. In this environment we didn’t find enough stocks that met our stricter investment criteria and so the cash balance remained high.
This month’s sharp decline in global stockmarkets has provided opportunities to deploy more cash. Two new companies have made it into the ‘top ten’ and we added to some existing investments. This resulted in the Fund’s cash balance falling to 3%.
Should we be selling some ideas we like just to get that cash weighting back up above 10%? Many, including some of my fellow Forager colleagues, think so.
You could argue that we have been able to take advantage of the recent sell off because we had that cash available, and that without that flexibility we won’t be able to take advantage of even better opportunities if they arise.
But we can always swap good ideas for better ones, especially given the International Shares Fund owns plenty of stocks with good liquidity. And it is my view that, provided that those best investment ideas are available, it is less desirable to hold cash at all times just because some opportunities might arise in the future.
I know this is a controversial stance – there is no doubt we will experience worse bear markets than this one – but I am more excited about today’s portfolio than concerned about the lack of ‘dry powder’. That is no guarantee that we will make money in the coming months. But I think that the current portfolio gives us a better chance to outperform in the long term than the old one did. And I also think it will beat one sitting on a huge pile of cash.
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