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MUTUAL FUNDS

Holding cash is part of their plan

By Mark Jewell
Associated Press / November 14, 2010

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Too much cash. It sounds like a nice problem to have.

It is, unless you’re a mutual fund manager sitting on client money while the stock market is rising. Stocks bloom, while a big piece of the fund manager’s portfolio gathers moss in low-yielding short-term bonds, money-market funds, or just plain old cash.

Investors scanning through a quarterly report may be puzzled to learn a fund is holding lots of cash. Why pay a money manager fees to, in essence, keep a sizable chunk of your cash under their mattress?

Yet many top fund managers routinely keep 10 percent or more out of the market and on the sidelines.

They may have good reasons for doing so. One common rationale: If a favored stock falls in price, a fund manager with a cash cushion can draw on those reserves to snap up the stock quickly.

“To be fully invested today is to assume there will be no better deals tomorrow,’’ says Mark Travis, comanager of the Intrepid Small Cap Fund. “And I’ve never operated under that assumption.’’

But cash can become a lead weight on a portfolio in a rising market. And all told, the market is up 9 percent for the year.

Consider the year-to-date numbers for Intrepid Small Cap and two other currently cash-heavy funds, all with 5-star ratings from Morningstar because of superior long-term returns:

■Forester Value is up 4 percent, trailing 99 percent of its peers specializing in large value stocks.

■Intrepid Small Cap is up nearly 16 percent, yet trails nearly 80 percent of its small-blend peers. The fund category is faring better than most because small company stocks are performing well.

■Osterweis is up nearly 8.5 percent, lagging 95 percent of its mid-cap blend peers.

Each of the managers acknowledged a key reason they’re lagging is their cash position: about 19 percent at Forester Value and Intrepid Small Cap at the end of September; and nearly 16 percent at Osterweis.

Those cash positions are around six times the average for all US stock funds, according to Morningstar.

Despite their recent back-of-the-pack results, managers at these three funds don’t have regrets about keeping so much money on the sidelines. Their explanations help illustrate why investors shouldn’t necessarily dismiss funds that are cash-heavy in a rising market:

■Tom Forester, Forester Value Fund:

When Forester is nervous about stocks, there’s good reason to pay attention. His fund was the only US stock fund to finish 2008 with a gain — it essentially broke even, up 0.4 percent — amid a market collapse that caused nearly every other fund to post double-digit losses. Many of his stocks were defensive picks that avoided major trouble.

At 19 percent cash — a level he calls moderate — Forester isn’t as pessimistic as he was entering 2008. But he frets about the Federal Reserve’s latest move: printing enough money to buy around $75 billion in Treasury bonds each month for eight months. The goal is to boost the economy by forcing long-term interest rates down.

With short-term rates already near zero, Forester worries the Fed’s move will do little to invigorate an economy. So he thinks a big cash cushion will protect his investors.

■Mark Travis, comanager, Intrepid Small Cap:

Intrepid Small Cap holds a concentrated portfolio of 50 stocks, with the top 10 holdings making up one-third of the fund’s $630 million in assets.

Travis likes to keep a cash cushion so he can pounce on stocks he’s looking to buy once they’re priced affordably.

The fund was nearly 39 percent cash during the worst of the financial crisis in September 2008. Months later, Travis started buying stocks at fire-sale prices. The fund used two-thirds of its available cash to buy bargain stocks, among them Pan American Silver when it was around $10 a share. Now, trading above $37, the stock remains among Intrepid Small Cap’s top holdings.

■John Osterweis, comanager, Osterweis Fund:

The fund held as much as half its portfolio in cash in 2008, and ended the year down 29 percent, better than about nine out of 10 of its peers.

Osterweis doesn’t see the fund’s current 16 percent cash position as extreme.

“The economy could fairly easily roll over into a double-dip recession,’’ he says, calling the range of possible outcomes over the next couple years “about as wide as we’ve ever seen.’’

With so much uncertainty, his fund’s cash stake provides flexibility. And it’s worth remembering how unkind math can be when markets sour. If your stocks lose 50 percent in value, you’ll need a 100 percent gain — not 50 percent — to get back to where you started.