How much cash do you hold and is it the "right" amount? This question has plagued investors for generations without much resolution. However, Warren Buffett's Berkshire Hathaway (BRK.A) (BRK.B) may provide some insight into the philosophy of holding cash assets.
Some may argue Mr. Buffett has been talking out of both sides of his mouth. Here is a quote from an Oct 16, 2008 New York Times Op-Ed written by Mr. Buffett:
Today people who hold cash equivalents feel comfortable. They shouldn't. They have opted for a terrible long-term asset, one that pays virtually nothing and is certain to depreciate in value. Indeed, the policies that government will follow in its efforts to alleviate the current crisis will probably prove inflationary and therefore accelerate declines in the real value of cash accounts.
However, keep in mind this quote was at a time when the markets were in disarray and equities were providing what has been proven to be historically great value (so far). Within the context of then-current market conditions, Mr. Buffett was encouraging investors to lighten up on their cash position and invest in equities. From the next paragraph:
Equities will almost certainly outperform cash over the next decade, probably by a substantial degree. Those investors who cling now to cash are betting they can efficiently time their move away from it later. In waiting for the comfort of good news, they are ignoring Wayne Gretzky's advice: "I skate to where the puck is going to be, not to where it has been."
Fast forward to an interpretation by author Alice Schroeder in The Snowball: Warren Buffett and the Business of Life, published in 2009. In an interview last week in Toronto, Ms. Schroeder said, as reported in the Globe and Mail:
"He thinks of cash differently than conventional investors," Ms. Schroeder says. "This is one of the most important things I learned from him: the optionality of cash. He thinks of cash as a call option with no expiration date, an option on every asset class, with no strike price.
Stated plainly, Mr. Buffett believes in maintaining a cash hoard to take advantage of individual good deals temporarily offered by the markets.
How much cash does Buffett's Berkshire Hathaway currently hold? As of the end of the 2nd quarter, the company held $40.7 billion in cash, $17.1 billion in the financial group and $23.6 billion in the commercial & industrial group. This is a 7.7% increase from the end of the 1st quarter as Buffett cut his holdings of consumer goods but did not reinvest all the proceeds. According to SEC filings, Berkshire sold $3.01 billion in stocks while reinvesting $1.85 billion.
However, the real story, and a takeaway for individual investors, is the percentage of cash being held at Berkshire. The following table outlines the level of cash on Berkshire's consolidated balance sheet compared to other assets:
Quarter Ending 6/12 (in billions): Cash: $ 40.7; Long-term Investments: $135.4; Total Assets: $411.3
Year Ending 12/11 (in billions): Cash: $ 37.2; Long-term Investments: $125.1; Total Assets: $392.6
Year Ending 12/10 (in billions): Cash: $ 38.2; Long-term Investments: $117.4; Total Assets: $372.2
Year Ending 12/09 (in billions): Cash: $ 30.5; Long-term Investments: $126.3; Total Assets: $297.1
Source: Yahoo Finance
From the table above, the amount of cash compared to the company's investment portfolio (calculated as l-t investments + cash) fluctuated between 19% and 23%, while the amount of cash compared to total assets has maintained a 9% to 10% range.
Where does Berkshire invest its cash? According to the 2011 Annual Report, cash equivalents consist of funds invested in U.S. Treasury Bills, money market accounts, demand deposits and other investments with a maturity of three months or less when purchased.
Most investors use a plain vanilla money market fund to store cash. Prior to the financial meltdown of 2008, money market funds were considered a "safe" investment where $1.00 invested would be worth $1.00 in perpetuity. But, during the meltdown, a money market provider "broke the buck" and the NAV was worth less than $1.00, creating a loss of capital if investors were to sell. On Sept 17, 2008, the Primary Fund, one of the originators of the money market fund concept, announced a freeze on all distributions for up to 7-days as its NAV fell below $1.00 with the write-down of Lehman Bros debt assets to zero. The first case of a money market fund breaking the buck occurred in 1994, when Community Bankers U.S. Government Money Market Fund was liquidated at $0.94 cents because of large losses in derivatives.
However, these are not the only money funds to have problems keeping their NAV over $1. According to a report published Aug 13, 2012 by the Boston Federal Reserve Bank titled "The Stability of Prime Money Market Funds: Sponsor Support 2007 to 2011," twenty-one money funds from 2007 to 2011 requested and received assistance from their management firms to shore up capital preventing them from breaking the buck.
According to the report, the worst offenders as a percentage of assets that were provided as support were:
Russell Money Market (RMMXX) with 14.0% of NAV support
SEI Prime Obligation Fund (TPRXX) with 4.3% of NAV support
Dreyfus Basic Money Fund (DBAXX) with 4.0% of NAV support
Columbia Cash Reserves (NCLXX) with 3.8% of NAV support
More on money market funds and alternatives will be discussed in future articles.
From the recent Globe and Mail article about Buffett's cash holdings (I highlighted the last paragraph as meaningful for those who use money or fund managers):
"The option theory of cash is something Mr. Buffett does not tend to get into when he is up on stage at his annual investor meeting, dishing out his homespun take on life and investing. That's probably because Mr. Buffett views himself as a teacher, and he wants to reach a broad audience", Ms. Schroeder says.
"Generally speaking, he likes to keep concepts simple," Ms. Schroeder says. "He says, 'I like to have all that cash around because you can use it.'"
However, it is a lesson that Ms. Schroeder said she wishes more people would learn. For many investors, there is a sense that holding cash is a cop-out. Investors who see their fund managers holding a lot of cash tend to think that they are not getting their money's worth, which is wrong, she says.
"If investors would realize that what they are paying for is someone to have the expertise to know when to buy a call option called cash, and move in and out of that, then perhaps there might be more value placed on that service."
The question remains: do you have more cash than Buffett as a percentage of assets? Using a Broad Asset Diversification Model, cash is given its rightful place next to the other asset classes for all portfolio analysis.
While the percentage of cash should vary based on an individual's risk profile and investment goals, Berkshire holds sufficient cash to achieve the goal of being able to meaningfully capitalize on potential value-priced opportunities.
Disclosure: I am long BRK.B.