Why Legendary Investors Are Drowning in Cash

Great investors tend not to jump in and out of the market based on where they think the Dow Jones Industrial Average will be in 12 months or whether they consider the S&P 500 slightly undervalued. They recognize that trying to time the market's ups and downs will more likely lead to frustration than to long-term success. Ordinary investors would do well to have the same mind-set.

By the same token, when several of the very best managers all say they are having an extremely difficult time finding anything to buy at prices that make sense--not just in the U.S. stock market, but in the bond arena and foreign markets, too--it's worth paying attention. In fact, it's remarkable how many top-flight managers currently have more than 20% of assets in cash and say they find compelling opportunities scarce to nonexistent.

The most prominent cash-hog is Warren Buffett. He's not a mutual fund manager, but he does have to decide where to allocate the substantial pile of cash generated by  Berkshire Hathaway's (BRK.B) insurance businesses. Lately he has been putting that cash into... well, mostly nowhere. We've discussed Berkshire's recently released annual report elsewhere, so I won't go into detail here. Suffice it to say that at the end of 2003 the percentage of Berkshire Hathaway's total investments languishing in cash was 22%--up sharply from the single-digit levels of the previous four years. That adds up to roughly $31 billion sitting on the sidelines.

Buffett considered most stocks too expensive even in early 2003, when the market indexes were far lower than they stand now. As he said in Berkshire's 2002 annual report, released one year ago: "Despite three years of falling prices, which have significantly improved the attractiveness of common stocks, we still find very few that even mildly interest us." And stock prices have soared since then. Bond prices also leave him cold right now. In Berkshire's new annual report, he says the junk-bond arena, which he considered quite cheap in 2002, doesn't look that way anymore. "The pendulum swung quickly…," he writes, "and this sector now looks decidedly unattractive to us. Yesterday's weeds are today being priced as flowers."

Bob Rodriguez, a two-time winner of the Morningstar Manager of the Year award, also knows something about bonds--and about stocks, too. And like Buffett, he's keeping plenty of money off the table these days. Rodriguez has a flexible mandate with  FPA Capital ; though stocks typically dominate that portfolio, he can look elsewhere, too. Lately he has found very little to his liking. At the end of February 2004, the fund's cash stake stood at nearly 26% of assets. That's not a first here--FPA Capital had roughly the same amount in cash in mid-1997. Still, it's rare for this fund to have more than 20% of assets sitting in cash.

In a mid-January 2004 letter to shareholders, Rodriguez explained that he and his colleagues have tried every which way to find attractive stocks, and have come up empty. "However we slice and dice Mr. Market," he wrote, "the result is the same, Slim Pickings." That goes for bonds, too. At  FPA New Income (FPNIX)--which, unlike FPA Capital, focuses on fixed-income securities--the fund's cash pile at the end of February was a staggering 38% of assets.

Managers Jean-Marie Eveillard and Charles de Vaulx of  First Eagle Global (SGENX), who also have a Morningstar Manager of the Year award to their credit, report similar troubles. Two weeks ago, de Vaulx told us that the lack of appealing, decently priced securities isn't limited to the U.S. stock market, but is widespread across asset classes and around the globe. Aside from a few small caps in Japan and Europe, he says he and Eveillard can't find anyplace to invest the fund's cash, which then stood at 23% of assets. And this for a fund that can freely invest in bonds, too. Sounding like Buffett, de Vaulx said high-yield bonds are overpriced now, too.

De Vaulx added that while bargains are scarce everywhere right now, the U.S. market is the most barren of all. As a result, First Eagle Global currently has a smaller percentage of assets devoted to U.S. stocks--less than 20%--than at any other time in the 25 years that Eveillard has been running the fund.

The list goes on. The cash-heavy club includes  Clipper Fund (CFIMX), run by other former Managers of the Year, and  Longleaf Partners (LLPFX), managed by past runners-up for that award. At year-end 2003, Jim Gipson, Michael Sandler, and the rest of Clipper's disciplined team had 26% of assets in cash and short-term notes. Meanwhile, at the end of February, Longleaf's Mason Hawkins, Staley Cates, and John Buford had 20.6% of Longleaf Partners' portfolio in cash. (The Longleaf trio also had nearly 19% of assets devoted to foreign securities--a rather high level even for those adventurous managers.)

When so many justly respected managers are sounding the same cautious note, it makes sense to listen. No need to overreact; don't shove all your money under the mattress. But take care if you've got a chunk of money to invest. Consider even more strongly than usual the option of putting it to work gradually--for example, dollar-cost averaging, or spacing investments out over time--rather than investing it in one fell swoop. Hesitate even more than usual if tempted to try to chase hot sectors. Even the greatest managers can't consistently predict the direction of the markets--and by and large, they don't try to. But right now, their words--and deeds--speak volumes.