Cautious value funds building cash

Five years after the 2008 crash, it’s happy days again for the stock market. So why is Patient Capital’s Vito Maida 75% in cash?

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From the February/March 2014 issue of the magazine.

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Cash doesn’t get much respect in this era of near-zero interest rates and surging stock markets. Levitated by central bank money printing around the world, it seems stocks are the only game in town.

But there’s a tiny band of veteran deep-value mutual fund managers who don’t want to play the greater-fool game. When the music stops, they won’t be scrambling for chairs because they’ve sat out much of the ascent.

Two interviewed early in the new year were fully 40% in cash: Keith Graham and Larry Sarbit, although Sarbit has since moved his cash down to 25% after buying two U.S. stocks. But both managers seem like riverboat gamblers compared to Vito Maida, president of Patient Capital Management, who’s 75% in cash for new accounts.

I originally got in touch with this trio for a web piece on portfolio rebalancing. I’d heard a few fund managers, like Black Creek Investment Management’s Bill Kanko, were finding it harder to find stocks fitting their value criteria. (He is indeed finding that’s the case, as you’ll see at the end of this column.)

But Maida’s extreme cash position goes well beyond rebalancing. “We are extremely cautious. Virtually every asset class is expensive and risky. The only place to hide is cash.” Cash levels are “at the high end of our historical range,” Maida says.

By cash, he is referring to short-term treasury bills maturing between three and six months. “Fixed income in my view is extremely risky with interest rates at zero.”

The cash positions held by these managers have little to do with broad top-down macroeconomic calls. They’re not taking stands on QEternity (Quantitative Easing 1, 2, 3, etc.) or tapering of bond purchases. They are simply taking a bottom-up fundamental assessment of stock values.

The few stocks Maida owns are North American, including a few undervalued dividend payers. But “in Canada it’s especially hard to find anything. Since early 2013 we’ve gradually been reducing positions as they hit our target prices. Now’s the time to be extremely careful and defensive.”

So far, his supremely patient clients are content to let Maida preserve capital. Since inception in 2000, returns have been gently rising, with less volatility than the major North American indexes, including in 2008. However, the minimum investment has been raised to $1 million.

For Larry Sarbit, the current era resembles 1999-2000, when he ran a fund for AIC famously 80% in cash. While he just deployed 15% of his cash, Sarbit’s moves have nothing to do with macroeconomic considerations like the Fed starting to taper. “It’s not dictated by anything but availability of something we like, like Sirius XM.” Sirius now makes up 8% of the IA Clarington Fund he runs. “I’m still telling people to give me money because I can top up positions that are still cheap. Clients won’t give us money when things get ugly and stocks get clobbered. Give it to me when you’re emotionally able and I’ll take care of it when stocks get ugly.”

Keith Graham, president of Rondeau Capital, started 2013 with 20% cash and is close to 40% as of early 2014. He knows cash loses purchasing power the longer it’s held but says it beats losing 40% on overpriced stocks.

I ask if, after the IPO of Twitter and various social media and cloud IPOs, if it feels like 1999 or 2007. “Funny, that’s exactly what I feel. It doesn’t make sense but you can dance while the music plays or stick to your beliefs. If there’s no value, I don’t own it.” His friends in the business feel the same. “They worry about the market, but may not be able to execute the same way.”

Advisers who sell mutual funds believe they hire equity managers to put cash to work so it’s up to them (i.e. advisers) and their clients to decide how much cash to hold. Even if they think stocks are overpriced, fund managers feel obliged to be almost fully invested.

As a “relative value” manager Sionna Investment Managers founder Kim Shannon says excessive cash equates to “essentially market timing.” In her recent book, The Value Proposition, she says she limits herself to at most 3% to 5% cash. The highest it got for retail clients was 18% in 2007-2008, “when we got really scared,” she told me before Christmas. “We’re not scared right now.” Most funds are almost fully invested with just 0.5% cash.

The Black Creek Funds Bill Kanko runs for C.I. Investments also have low cash levels of 3% to 6%. “Value is relative. After two years of strong markets, equity prices are up 60% or 70%, so of course it’s harder to find value. Equities are priced for mid to high single-digit returns the next five years, relative to bonds at 3% or 4% and versus inflation. That’s good but the returns of the last few years are clearly unsustainable.”

Clearly.

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