Buffett builds US$55b green pile as individual investors cut cash holdings
Large holdings allow Berkshire's boss to make an investment when the right deal comes along and give him protection against the downside
Individual investors have been cutting back on cash in portfolios, the exact reverse of what Warren Buffett has been doing at Berkshire Hathaway.
Who do you think has got it right?
Cash at Berkshire Hathaway stood at just over US$55 billion at the end of June, a record high and 21/2 times the level Buffett had said in the past he liked to keep on tap to meet extraordinary claims at his insurance businesses. It was also up more than 50 per cent year on year.
Buffett's green pile was in sharp contrast to individual investors, who had cut cash in portfolios to 15.8 per cent, a 14-year low, the July asset allocation survey from the American Association of Individual Investors showed.
To be sure, businesses and individuals hold cash for different reasons, but Buffett has used Berkshire, in part, as an investment vehicle through which we can interpret his views on markets, or at least the prices of some assets in them.
Berkshire, of course, has some difficulties in putting cash to work that are not faced by your average dentist or lawyer, in that it tends to make very large investments and as such may need to be more patient than smaller fry. So it is quite possible it is waiting for the right acquisition to come along.
It is also similarly possible that Buffett is not happy with the prices and is biding his time against a day when prices have been marked down. One thing not influencing Berkshire is tax policy as all its cash is generated in the United States and it is not one of the legion of corporations holding money offshore to avoid a repatriation tax.
The bottom line, though, is that the best investor in the world is going in exactly the opposite direction to a class of people often reputed to be among the worst.
Cash returns are, as we know, lousy; the little that one can get in liquid instruments inevitably being lower than the toll extracted by inflation. And the long-term returns on cash are indeed terrible, lagging every asset class and investment strategy this side of setting money on fire.
Still, looking at the long-term returns on cash and concluding it is a tool to be shunned is a bit like saying a golfer ought not to have a back swing because only forward momentum drives the ball. Cash is the thing that puts you in a position to drive the ball and gives your investment swing power. Its value lies not so much in itself but in the ease with which it can be turned into other things.
Cash is worth holding because it is dry powder that gives the owner options. That optionality varies, of course, based on your view of how richly valued assets are, but it is always there.
Cash also provides investors with what so many hedge funds and other expensive financial products claim to provide: protection against the downside. James Montier, of fund managers GMO, calls cash "perhaps the oldest, easiest and most underrated source of tail risk protection". If you are worried, as small investors seem not to be, about the small possibility of large-impact events, then cash has a value not expressed by its yield.
Montier also argued, in a 2011 paper, that cash provided decent protection against both inflation and deflation, citing the experience of the US inflation of the 1970s and Japan since 1990. During the '70s, cash was a bit worse than equities as inflation soared, but a bit better than bonds. In Japan, in contrast, cash did much worse than bonds, but, as goods and services declined in price, did far better than stocks.
But really if cash has something to recommend it in the current environment, it is its optionality in a time of uncertainty. The odd thing about the current market is how calm it is in the face of fairly unprecedented conditions.
We have never before been through a lift-off from zero rates or a running down of a massive Federal Reserve balance sheet. Likewise, we have never run into a recession while also being at the zero lower bound for interest rates.
Any of the above is possible in the next 12 to 24 months, and yet markets are not even close to pricing these risks.
While it may never happen, and we might want to cheer up, Buffett is arguably better positioned with his cash roll if it does than the small investors who are nearly as heavily invested as they have been this millennium.