Fund Managers With Hordes of Cash to Perform Well
March 2, 2009
In this brutal market, mutual funds that have kept a large stash in cash have performed best, according to Morningstar. Plus, these funds are best-positioned to take advantage of the market once it turns around. "Many of the funds that held up the best in this brutal market have one thing in common-cash," said Greg Wolper, a Morningstar analyst.
Funds with money stashed on the sidelines not only have an advantage when the market plunges, but if manager's stock picking is on target, they could do well in an economic recovery. Those with large cash positions can buy both cheap growth and value stocks in companies with good long-term earnings potential. They are also better positioned to honor redemptions without being forced into untimely sales of positions.
Most mutual funds stay fully invested except for a small cash position of about 3%. That's because they must remain true to their investment styles so financial advisers and investors can diversify by asset class. Over the long run, this type of asset-allocation reduces the volatility of a portfolio. But in light of the market turmoil, more mutual funds are flouting traditional cash levels.
In fact, the 100 funds with the largest cash positions range from 27% to 100%, according to Morningstar. The Embarcadero Small-Cap Growth Fund has 100% in cash. Meanwhile, U.S. Global Investors All American Equity Fund has 27% in cash.
It's not necessarily a sure thing that funds with large cash positions will put the money to work correctly when the stock market rebounds. But on average, funds that own thinly traded stocks will benefit most when the managers have a lot of cash, according to a study released in January by Itay Goldstein, finance professor at the Wharton School of Finance at the University of Pennsylvania.
Ron Muhlenkamp, manager of the Muhlenkamp Fund, has had as much as 30% in stocks over the past year. He believes he is in good position to invest in a large number of undervalued stocks based on future earnings.
"We began putting our cash to work," he said. "Bank balance sheets are much stronger partly due to infusions of capital by the U.S. government. Leverage on the balance sheets of brokers and hedge funds has been reduced dramatically. Mortgage rates have declined significantly."
Muhlenkamp invests in all types of stocks regardless of market capitalization. But the companies must have attractive price-to-earnings multiples and return-on-equity measures. His average holding sports a price-to-earnings ratio of just 11.5 times earnings. Return on equity averages 26.4%. The fund's largest holdings include Philip Morris International, UnitedHealth Group, Berkshire Hathaway, International Business Machines and Cisco Systems.
Robert Rodriguez, manager of the FPA Capital Fund, has a long history of going to cash when the markets trend down. He's held large cash positions since 2004 due to concerns about economic health. The fund has nearly 34% in cash. On the stock side, he invests in out-of-favor smaller companies that are inefficiently priced by Wall Street analysts. Companies should have an understandable and successful business strategy with good management. But Rodriquez has reduced his stock positions because corporate profitability is not up to expectations.
Rodriquez turned bearish in the fourth quarter of 2007 because he believed the economy was heading into a recession. As a result, he has been tight-fisted with his investments. He is not optimistic. He's forecasting just a 5% annual return on stocks over the next several years.
His strategy is to invest in companies with strong balance sheets and a lot of cash on the books. The fund's largest holdings include ENSCO International, Avnet, Arrow Electronics, Patterson-UTI Energy and Rowan Companies.
William Gross, manager of the PIMCO StocksPLUS Institutional Fund, has even more in cash. The fund has 46% invested in short duration fixed-income assets. The rest is in the S&P 500 Futures Index. Gross' fixed-income assets have a duration of less than one year. This means that if interest rates rise or fall by one percentage point, the value of the securities will increase or decrease by about the same amount.
The goal of the fund is to perform as well or better than the overall stock market by investing in stock futures. The aim of actively managing the short duration fixed-income assets is to add incremental return above the S&P 500 Index. The S&P futures contracts are priced such that a combination of futures and money market investments normally produce a return equal to that of the S&P Index.
Over the past year through January, the fund lost 46%, in line with the S&P 500.
Gross believes that the global economy is in a state of "deflationary momentum." So the U.S. government economic stimulus, the Fed's monetary policy and recapitalization of the banks should result in greater liquidity and economic stabilization.
"To PIMCO, the remedy for this deleveraging and mini-depression is simple and almost axiomatic-stop the decline in asset prices," Gross said.
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