These Funds Hold Cash When Opportunities Are Scarce

Fund managers keep cash in their portfolios for many reasons. Cash helps to manage outflows, for example, so that managers aren’t forced to preemptively sell holdings. The proliferation of exchange-traded funds and the widespread use of derivatives have lessened these liquidity needs and allowed funds to operate with much lower cash reserves. These days, it’s common practice for funds to remain near fully invested at all times.

But cash can be more than a mere buffer for liquidity; it can also serve as a strategic asset or a tool to mitigate risk during market stress periods. Proponents of the efficient-market theory view holding excess cash in anticipation of better buying opportunities as tantamount to market-timing—a futile endeavor. While there is plenty of empirical support for this view, some fund managers see things differently. Absolute value investors, for example, believe securities routinely trade at prices well below their intrinsic values, creating opportunities for shrewd investors. For these value-oriented funds, a buildup of cash often indicates that attractive investing opportunities have become scarce.

Portfolio managers David Samra and Ian McGonigle of Artisan International Value ARTKX have earned this fund a Morningstar Medalist Rating of Gold by seeking quality firms with financial strength and shareholder-oriented management teams that are trading at about 30% below the team’s intrinsic value estimates. When stocks meeting those criteria are scarce, the managers will let cash build, allowing them to be aggressive when markets falter. For example, the fund’s cash stake was 12% in December 2019, but the coronavirus-driven selloff in 2020’s first quarter allowed them to put most of that cash to work by the end of that quarter when cash fell to 1.5%. Cash again approached 12% by September 2021, and the team opportunistically deployed it in 2022 as markets faltered.

Nimble repositioning has allowed Artisan International Value to thrive in both up and down markets. From when McGonigle joined the roster in October 2018 through October 2024, the fund captured 112% of the foreign large-blend Morningstar Category’s upside and just 96% of its downside. As of September 2024, cash was 12.1% compared with 6.1% for the category average.

Sitting on the sidelines with cash often means being prepared to underperform in bull markets. That’s been the case with Bronze-rated Royce Small-Cap Special Equity RYSEX, which has consistently lagged on the upside. It also underperformed small-value peers over the largely upward-moving trailing 10- and 15-year periods through October 2024. But the fund has consistently lost less in drawdowns because of Charlie Dreifus and his team’s uncompromising stock-picking, which can manifest as large cash stakes when valuations become heady. Cash has ranged from the midteens to nearly 20% in recent years.

When panic rocked markets in 2020’s first quarter, a defensive posture helped this Royce fund outperform its Russell 2000 Value benchmark by 14 percentage points. It also held up well in the early 2000s’ internet stock bust and during the global financial crisis in 2008-09. As of Sept. 30, its cash stake stood at 16.1% versus 1.4% for the typical small-value peer.

An outsize cash position can also signal a willingness to stand out from the crowd. Managers Steve Romick, Brian Selmo, and Mark Landecker of Silver-rated FPA Crescent FPACX are absolute value investors who often go their own way. They, too, will stockpile cash when they can’t find opportunities in the market, and the fund’s wide-ranging remit allows them to put that cash to work wherever opportunities arise. Around the turn of the century that meant investing in small caps. In 2008, management turned to high-yield and distressed debt. In both periods, cash still constituted more than a third of the portfolio, indicating the team’s pickiness even when going off the beaten path.

The FPA Crescent team has since shifted to durable “compounders,” out-of-favor cyclicals, and non-US stocks. It has even dabbled in convertible bonds, special-purpose acquisition company investments, illiquid shipping containers, and offshore drilling vessels. As of Sept. 30, cash represented 11.4% of the portfolio compared with 0.3% for a typical fund in the moderately aggressive allocation category.

This article first appeared in the November 2024 issue of Morningstar FundInvestor. Download a complimentary copy of FundInvestor by visiting this website.