Most institutional investors and virtually all professional money managers subject themselves to a rule that they must be fully invested at all times. They think they must choose between earning nothing in cash and earning something in bonds or stocks, or they bow to the pressures of the job that include: (1) defining risk as the volatility of a stock compared to that of some benchmark instead of defining risk as the chance of permanent capital loss; (2) short-term performance pressures; and (3) dissatisfaction from clients who don’t want to pay their wealth manager for holding cash, something they assume they can do on their own and for free.
The result is most financial advisers will invest every last dollar, even if they believe stocks are at speculative prices or they find the returns among fixed income securities to be too low.
We think of cash differently: we believe cash is always an investment consideration. In times of speculative excess, or when we believe the market hasn’t sufficiently discounted rising risks and uncertainties, we’d rather invest in cash and wait for better opportunities.
To us, cash is not just an asset class that is returning next to nothing. Cash is a call option to buy anything, and often that option is valuable. Cash is not just a buffer that softens the blow of a market pull back or calamity. It is also a driver of gains, allowing an investor to wait for the prices of at least some securities to drop. In other words, cash allows an investor to seize opportunities and generate higher returns.
Today’s conventional investment wisdom argues that holding significant cash is equal to market timing and gambling. But isn’t it gambling to assume that investing means always buying something, especially when one is choosing among a poor opportunity set? Why should only today’s opportunity set be considered when tomorrow’s might be much better?
Investing isn’t just “staying in the game” and buying good stocks and discarding bad ones. Investing includes a constant process of looking at assets, discounting their future cash flows and inherent value, and deciding if one is getting more value than the cash price paid. And if there aren’t enough good values out there, how can holding on to a good amount of cash be gambling?
Comparing what one’s getting versus giving—this is central to investing. Thinking. Yes or no decisions. Not beta optimization or otherwise extrapolating past returns. At Cadinha & Company, the constant risk tradeoff between asset classes has been central to our investment process since our founding in 1979.