Why Montgomery funds' largest position (by far) is cash

In value investing, patience can be a virtue, and we think holding cash will pay off.  But, of course, not everyone will agree with us. Nobody knows how long it will be before value emerges broadly, it might be worth examining a selection of comments made by central bankers and fund managers.

You may be surprised to know that our largest position by far is cash.  And that’s because we’re not finding value among the quality businesses we like to own. In value investing, patience can be a virtue, and we think holding cash will pay off handsomely.  But, of course, not everyone will agree with us.

The Montgomery Fund holds 27 percent cash.  The Montgomery Global Fund holds 27 percent cash, and The Montgomery [Private] Fund holds 43 percent cash (the fund can hold up to 100 percent cash).

Such high levels of cash, earning minuscule rates of interest, are going to drag performance in a rising market. Our direct investing clients value the preservation of capital above earning the last few percentage points of a market’s gain, especially when market valuations are stretched as they are now.

While we have not lost money recently, we haven’t made much either, and while the optimists are winning, our high cash weightings produce embarrassing relative returns.

Because nobody knows how long it will be before value emerges broadly, it might be worth examining a selection of comments made by central bankers and fund managers, while we wait.

Dividing sentiment into two camps, those currently in the lead are the bullish investors who are backing an acceleration of global economic growth favouring higher resource prices including copper and iron ore.  This is the ‘global reflation’ trade and supporters look to recent hawkish comments by central bankers to support their case;

Australia’s RBA Governor Phillip Lowe (Feb-17) was the first to highlight that inflation targeting was no longer dictating the bank’s rates setting. He commented that while colleagues were arguing the bank should be doing more to get inflation back to its target, by cutting rates further, he was concerned about “how much extra fragility would that create in the economy” by encouraging further growth in household debt.

US Fed Chair Janet Yellen (16-Jun-17) stated: “And, you know, I continue to believe though that with job growth running well in excess even with the moderation of the level that’s needed to provide for new entrance in the labor market, we do have a strengthening economy with policy accommodative, all that we’re doing in raising rates is moving — removing a bit of accommodation heading toward a neutral pace.”

ECB President Mario Draghi (27-Jun-17) delivered a bullish assessment of the region’s economic prospects, saying that reflationary pressures have replaced deflationary ones as the Eurozone’s recovery progresses.

BOC Governor Stephen Poloz (28-Jun-17) stated: “It does look as though those (rate) cuts have done their job.”

BOE Chief Economist Clive Haldane (20-June-17) stated: “Having weighed the evidence, I think that the balance of risks associated with tightening ‘too early’, on the one hand, and ‘too late’, on the other, has swung materially towards the latter in the past six to nine months… Certainly, I think [such] a tightening is likely to be needed well ahead of current market expectations.”

In the other camp are those lauded and legendary fund managers who believe stretched equity valuations, record low levels of volatility, stretched prices more broadly across all assets, the concentration of funds flowing into a narrowing group of tech stocks and speculative fervour amid buyers of non income-producing collectibles are all signs that raised cash levels are sensible.

Ray Dalio, founder of Bridgewater Associates LP, the world’s largest hedge fund with more than $150 billion under management, believes the “magnitude” of the next downturn will be epic. “We fear that whatever the magnitude of the downturn that eventually comes, whenever it eventually comes, it will likely produce much greater social and political conflict than currently exists,” he recently said.

Bill Gross, founder of PIMCO LLC and now portfolio manager at Janus Henderson, cites the highest risk levels since 2008: “investors are paying a high price for the chances they’re taking.”

CEO of DoubleLine Capital Jeff Gundlach advised, “moving toward the exits.” Gundlach is reducing his positions in junk bonds, emerging-market debt, and lower-quality investments, because he believes investor sentiment will turn negative, telling Bloomberg: “If you’re waiting for the catalyst to show itself, you’re going to be selling at lower prices.”

Carl Icahn, who regularly loads up on stocks and hits it out of the park, warned on CNBC in June that he isn’t seeing opportunities; “I really think now, I look at this market and you just say, ‘look at some of these values,’ and you have to wonder.”

Oaktree Capital’s founder Howard Marks in his latest letter to investors, stated: “The uncertainties are unusual in terms of number, scale and insolubility in areas including secular economic growth; the impact of central banks; interest rates and inflation; political dysfunction; geopolitical trouble spots; and the long-term impact of technology.

In the vast majority of asset classes, prospective returns are just about the lowest they’ve ever been.

Asset prices are high across the board.  Almost nothing can be bought below its intrinsic value, and there are few bargains. In general, the best we can do is look for things that are less over-priced than others.

Pro-risk behavior is commonplace, as the majority of investors embrace increased risk as the route to the returns they want or need.”

George Soros is reported to have recently sold stocks and bought gold… after a near 10-year hiatus.

Appaloosa Management’s David Tepper warns investors to stockpile some cash and says he’s “on guard”.

It’s fair to say there are those who also believe in other scenarios such as a continuation of slow growth requiring no change to current interest rates settings.

Irrespective of what camp we might personally believe in, our process is being strictly adhered to and that process isn’t finding large amounts of value among the quality names we like.  But we aren’t going to change our process.  As a result, cash is the safest alternative and for as long as it remains Montgomery’s largest portfolio position, a rising market – especially the Australian market which is 17 percent weighted to materials (compared to 2.9 percent in the US) – will snub its nose at our apparent conservatism and make our process look dumb. As Howard Marks noted, currently the optimists are winning.

So which camp are you in?