Escape Is Rarely the Safest Bet

Don't tell Brandywine Fund that fleeing stocks for cash is a safe, conservative maneuver.

In 1997, at the outset of the greatest bull market of all time, Brandywine had a disastrous experience with a move to cash when it concluded that the markets were getting too rich and began dumping most of its stocks. Then, with 75 percent of assets in cash, it watched helplessly as technology stocks surged in the first quarter of 1998. Convinced of its error, the fund shifted back to stocks in April — just in time for a big summer selloff. Shareholders withdrew billions of dollars, while journalists assailed the fund for inept market-timing.

The Brandywine debacle underlined the hazards of holding big cash stakes. Today, many funds remain fully invested, even in down markets. But in recent months, a number of top-performing selections have begun holding up to 40 percent of their assets in cash stakes. After a year of sizzling markets, stocks have gotten too rich, managers say. Unable to find enough bargains, the funds are content to let cash accumulate. Funds with more than 10 percent of assets in cash include Clipper, First Eagle Overseas, Longleaf Partners, FPA Capital and Mutual Shares.

The flight, however, is not limited to stock funds. Bond funds with more than 30 percent of their assets in cash include PIMCO Total Return A and FPA New Income.

The Plight of Flight

For advisors, movements to cash pose problems. “We try to avoid funds that flip-flop because it throws off our asset-allocation plans,” says Ross Levin, president of Accredited Investors, a financial advisory firm in Edina, Minn.

Several years ago Levin sold his position in Clipper because the fund sometimes moved from being fully invested to holding more than 30 percent in cash. But Levin says that it is often hard to stay away from cash-holding funds altogether. After First Eagle Overseas increased its cash stake to more than 20 percent last year, Levin considered selling, but he decided to wait because of concerns that clients would have faced big capital gains tax bills. “We don't automatically sell a fund that shifts to cash, but we try not to allocate new money to it,” he says.

Not all advisors are troubled by temporary cash positions. “In the current market, many stocks are overvalued, and cash may make sense,” says Lawrence Scharf, a financial advisor with Advest in Westport, Conn.

Some top value funds routinely hold cash as part of a disciplined strategy that seeks to avoid overpaying. As part of their due diligence, advisors should understand whether a fund sometimes holds cash and make sure that the strategy suits their tastes. “If a very smart manager can't find bargains, then there is nothing wrong with holding cash for a few months,” says Scharf.

Make no mistake: shifting to cash can backfire. But there are a few funds that have demonstrated a deft touch, delivering strong returns while holding cash periodically. Unable to find stocks selling at discounts in markets around the world, First Eagle Global A now has about 22.9 percent of assets in cash. Diehard value investors, portfolio managers Jean-Marie Eveillard and Charles de Vaulx last held such a big cash stake in early 1994. The move to cash proved well-timed. With the Federal Reserve raising interest rates, stocks dipped. First Eagle used its cash to scoop up cheap stocks, finishing the year in the black and ranking as the top performer in the global group.

Now de Vaulx hopes to repeat that success of a decade ago. “The cash is only a temporary position,” he says. “We figure that in six or 18 months there will be a time when stocks will come down and we can buy bargains.”

Even with a cash stake approaching 15 percent, Longleaf Partners clobbered the S&P 500 in the rising markets of 2003. Steady deep-value stockpicking helped the fund stay ahead. Most of the time, portfolio managers Mason Hawkins and Stanley Cates have single-digit cash positions. But in the difficult year of 2001, they shifted to holding 16.5 percent of assets in cash. That helped Longleaf return 10.3 percent for the year, more than 22 percentage points ahead of the S&P.

Seeking to limit risk, Mutual Beacon stays broadly diversified, holding a mix of cash and undervalued stocks and bonds. The strategy enables the fund to boast one of the lowest standard deviation figures of any equity fund. Besides reducing volatility, the cash hoards provide ammunition for quick moves. The fund — which currently has 18.5 percent of assets in cash — often takes sizable positions in special situations, such as mergers or reorganizations, that tend to appear suddenly.

“Some of our best investments have occurred in frightening situations where it pays to act decisively,” says Mutual Beacon portfolio manager David Winters.

Tipping the Balance

A balanced fund, T. Rowe Price Capital Appreciation typically holds a mix of stocks, bonds and convertibles. But lately portfolio manager Stephen Boesel has cut back on his covertible allocation and reduced bonds almost to zero. Meanwhile, cash stands at 20.3 percent of assets, the fund's highest allocation to the sector in a decade. Boesel fears that convertibles have gotten rich after enjoying a big run last year. He's staying away from bonds because rates seem poised to rise, which would hurt fixed-income prices. “Interest rates are very low, and even a small increase would push bond total returns into negative territory,” he says.

The cautious attitude has paid dividends for T. Rowe Price shareholders. During the past decade, the fund has returned 13.2 percent annually, outdoing the S&P 500 by more than 1 percentage point, while never recording a losing year.

Even at a time when many bond managers worry about rising rates, FPA New Income is notable for its defensive stance. To avoid suffering losses, the fund holds 36.7 percent of assets in cash. That is an unusually big cash stake for the fund, but not unprecedented. In 1998, with economies melting down in Russia and Asia, FPA shifted to cash for protection against uncertainty. In 1993, the fund also held cash to protect against rising rates. The aggressive shifts have helped it compile a remarkable record; since it began operating in 1984, FPA has never reported a losing year.

FPA's assistant portfolio manager Tom Atteberry concedes that the cash stakes penalize the fund when rates fall, and competitors surge ahead. But he says clients rarely complain about the temporary lags.

“We communicate with people upfront that using cash can help preserve capital,” he says, “and most clients are willing to accept the approach.”

Comfort in Cash