Cash gives the private investor an edge – By Merryn Somerset Webb

Fund managers don’t like holding cash, but individual investors can and should

I wrote last week about the many ways in which traditional long only fund managers are institutionally prevented from performing as well as they should – given their above-average intelligence and ample resources.

But there was one thing I left out. It is that the majority of fund managers never hold cash as an asset class. They don’t consider it to be part of their job.

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It isn’t just individual funds that veer away from cash. The industry as a whole is also very keen to encourage us all to be fully invested at all times. It isn’t good for them for us to be sitting around with our money in savings accounts losing money to inflation, as opposed to being in investment funds and losing money on fees. Hence the regular press releases pointing out the difficulty of timing the market and the hideous long-term results of being out of the market on the two, four, five or perhaps 10 best days of the year. The propaganda works; almost all investors avoid holding cash.

Ask anyone with a neat nestegg sitting in the bank how they feel about it and they’ll answer that they’re mildly guilty that it isn’t “working” for them. But the truth, I think, is that being able to sit in cash– without having to put up with snide remarks about being paid to do nothing – is yet one more factor that gives the intelligent private investor an edge over the intelligent institutional investor.

The key to this is to think of cash as offering what economists like to call optionality. Sure, it hasn’t been a comfortable thing to hold over the last six months as markets have frothed and bubbled and inflation has eaten away at its purchasing power. But great fortunes don’t rest on holding what other people are holding at the top. They rest on being able to buy what other people can’t afford at the bottom.

I spoke to James Montier of GMO at the London Value Investor Conference a few weeks ago and asked him how much cash he holds. The answer was that his own assets are in the GMO Global Asset Allocation Fund, one of the few that is comfortable holding cash and right now is awash with the stuff.