Value Investment Research | Port Wren Capital | Is Cash in Your Portfolio a Good Strategy? Portfolio Management

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Many investors of all types whether value or growth argues the merits of holding cash as a position within their stock portfolio. Peter Lynch, a famous fund manager who ran the Magellan Fund for Fidelity Investments for many years, believed in being fully invested at all times and thus did not hold cash in his portfolio as a strategy. He wanted to be earning money all the time on all his capital. In contrast, Seth Klarman, a value investor running the Baupost Group, believes in holding cash is a necessary part of his portfolio and plays a critical role in his overall strategy. Reports in the third quarter of 2015 indicated his fund held more than 40% in cash.

Klarman’s favorite edge against a volatile market is a cash position. Klarman believes that there will be plenty of opportunities to deploy this capital going forward. On one side, a valid argument can be made to not hold cash. Since, the objective of any stock portfolio is to put your capital to work and earn a high ROI as possible. Having cash on hand, typically does not earn any real return compared to its potential when invested in stocks, when it just seats there not invested on the sideline. And this is all too true and makes good sense.

However, on the other side are those that believe cash should be held. It also makes good sense. Provided you view the cash position as an optional tool that can be used to your advantage. Especially if you are a value investor, granted while holding cash your gain is insufficient. The key is when an unexpected event occurs that has great ROI potential and your other capital is fully invested and those positions have not yet reached their total potential. With the liquid cash on hand, you can take full advantage of the unexpected event where had you no cash on hand you would have lost the option to act.

A good example, of this was in 2015, when the price of oil per barrel suddenly went from about $100 to $35 per barrel in a matter of months, not years. There was no advance warning and the price drop happened very quickly. With the cash position, Port Wren Capital, LLC, was able to invest in some related oil & gas companies that were suddenly undervalued due to this unexpected situation. In this case, the event had a negative impact only on the oil & gas sector and not the overall market. Another example where would be back in 2009 after the banks defaulted when the market responding by selling volumes of shares of equities. Many firms associated with banks became undervalued. This created a number of opportunities to use the cash on hand. In particular, Port Wren Capital, LLC found a firm that was negatively impacted by the banking crisis and used some of our cash to buy MHP at $44.26 per share in early 2013. Later that year, we sold it at $73.98 per share at a 67.15% gain. Also, back in the Fall of 2015, the Chinese stock market dipped for several days causing a large sell off in the US stock market that in turn lowered many stocks prices and chances to use some of the cash on hand.

Here is another consideration to think about. Are we not taught as investors to place more emphasis on a company that has excess cash on hand compared to those that do not? Why would that same logic not be applicable to our own portfolio? Cash provides flexibility. And typically opportunity comes from being flexible enough to respond to those opportunities. Seth Klarman also reminds us, "Graham's wonderful sentence as, an investor need only two things: cash and courage. Having only one of them is not enough."

In summary, both arguments; having a cash position and being fully invested at all times have their own benefits, as well as, their drawbacks. And as such, they are both valid and useful strategies to be used by an investor. Which one should you use? Select the one that best matches your investment strategy and therefore provides an edge that compliments its objective. Clearly for a value investor driven by events the cash position is a great asset that provides flexibility and in the long-term sees many merits. On the flip side, being fully invested is the smart way to go if you are say a growth investor that buys and holds over a long time frame.

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Is Cash in Your Portfolio a Good Strategy? - Portfolio Management