Observing Your Cash

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Over the past several months my mind has been wandering to a strange place where I am hoping to see a market drop. You must be thinking I am completely losing it… Why would I ever want the markets drop? The reality is that markets will always have ups and downs, and over the past year or so we have seen a lot of up.

One of the side effects of a rising market is that managers tend to start raising cash. Lately, I have noticed the cash positions in most of the funds I closely track are higher than normal.

Before I deeply discuss the cash positions, I’d like to take a moment to remind everyone of the process that many of my preferred mutual funds use. First, they diligently comb the globe to seek out the best companies they can possibly find. Once they identify the highest quality companies, they thoroughly assess what they believe the intrinsic value (the true value) of the stock should be. Then they wait until the company share price is below this intrinsic value… in many cases, 30% or more below. Assuming all factors of the company they’re watching are still in-tact, this would be a signal to buy the stock.

Over the past few years we have seen markets preform very well. I hope you have noticed this when you have been receiving your quarterly statements. As a result the stock prices of most companies (including the stocks that your managers have identified) have been rising. This will lead to fewer companies on the managers ‘watch list’ trading at the desired 30% or better discount to the true value. In many cases they would rather hold extra cash, than risk buying a stock at the wrong price.

Getting back to my main topic about cash, you can see in the chart below some of the more recent cash allocations for some of my favorite funds:

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Source: All calculations were provided by their respective mutual fund companies and are believed to be accurate and true.

There are pros and cons to having extra cash on hand. The biggest benefit is that it is not exposed to market volatility. If we go through a downturn of any kind, the cash portion of your investment will not be affected, thus it would lessen the impact of a correction on your funds. Also, if said downturn was to occur, the cash will come in handy when the share prices of the stocks on your managers watch list move to more attractive values. They would be buying on the dip. The cons of cash are much the same as the pros, if the markets never drop and continue to increase in value, you are also not participating in as much of the upside performance.

To be clear, I am not discussing the cash positions to make a market call, or to warn that a downturn is imminent. I think it is important for my clients to understand the behind the scenes process and be confident that your funds are prepared for the possibility of volatility coming back into the markets.

So what do we do? As usual my recommendation is to stay the course with what you have. Diversifying among the various managers will provide you with a variety of views (both optimistic and cautious) and they are all working to find the best opportunities the can without taking unnecessary risks. Nobody can predict or control the direction of the markets, but they can (at the very least) make prudent choices to help lower your risk and ensure you never overpay for any of the companies in your portfolio.

In the meantime the managers will continue to grind away at finding great companies and we will continue to monitor them, to ensure they stick with their disciplined approach.

We hope you are enjoying the summer weather. We certainly deserve it.

Best,

Andrew & Peter

#investing

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