Hoarding Cash in Times of Trouble


By Sam Jaffe Some money managers respond to bear markets by putting all their assets to work as stock prices get insanely cheap. Others react by crawling into a cave and waiting for things to get better. I set out to locate a few cautious mutual-fund managers with high cash positions -- the cave dwellers -- and find out when they plan to go back out into the sunshine.

What I found was the Parnassus Fund (PARNX), which has been hibernating for more than nine months and still isn't ready to come out. Parnassus is a rather unusual fund that sometimes defies categories. For one thing, it's a socially responsible fund that actually has a good track record on delivering solid returns. (Alas, many funds that screen out "sin" stocks commit the sin of poor returns.)

Over the last 10 years, according to Morningstar Inc., the fund had an average return of 17.5%, compared to 12.7% for the S&P 500 during the same period. Also, it has a long history of making big bets on out-of-favor stocks that others might avoid -- with surprisingly successful results.

DRY POWDER. This is a value-investing fund through and through. But when Parnassus manager Jerome Dodson couldn't find any good value stocks to buy in the slumping market a year or so ago, he stopped buying. By the beginning of this year, more than 50% of his portfolio was sitting in cash. By the end of September, that number was up to 62%, and it won't budge much from that point for at least another month. "It's too hard to make money to lose it," explains Dodson on why his fund is keeping its powder dry.

Of course, every fund has latitude under Securities & Exchange Commission rules to keep a small portion in cash in order to meet sudden shareholder redemptions. It's not uncommon to see stock funds with cash positions of 15% or 20%, especially in times of volatility or market downturns. But going as high in cash for as long as Parnassus has is nearly unheard of.

Indeed, as of Sept. 30, only eight funds had cash positions that were higher than 60%, according to Morningstar. Of those, six were specialized funds that use complex portfolio strategies involving reverse repurchase agreements and commercial paper in order to leverage their bets on the stock market. The only other Parnassus-style cash-hoarder is FlexFunds Muirfield Fund (FLMFX), which declined to comment for this story. It's a so-called fund of funds that invests in other mutual funds and claims to be involved in "defensive investing."

SUPPORTIVE SHAREHOLDERS. Despite Dodson's near pullout from the stock market, the fund manager says shareholders have supported his move. "We've gotten more love mail than hate mail," he says. "Some shareholders have contacted me questioning why I wasn't in the stock market more heavily. But after I explained what I was doing, they were very understanding. We've had very few redemptions."

What Dodson is doing is timing the stock market. When he couldn't find enough stocks that he deemed worthy of this investing dollars at the end of last year, he just stopped investing. He didn't completely pull out of the market, as Muirfield did. Dodson still owns 19 stocks, including FannieMae (FNM) and PetSmart (PETM). But most of its money is tied up in an old-fashioned savings account.

This has been a good year to be in low-interest-bearing savings accounts and absent from the stock market. Yet even putting the money under the mattress has been't been enough to stave off a slight hit. Parnassus is down 3.4% through the end of September. Compare that to the 17.9% dive that the S&P 500 has taken.

FOUR REASONS. So when does Dodson think it will be time to get back into the market? Tentatively, he's looking at early November. He has four reasons for that. The first is that he expects mutual-fund tax-loss selling to continue through the end of this month. "Most mutual funds end their fiscal year in October, and a lot of them have lost a lot of money this year," he observes. "They'll want to get some of the tax benefits of that by selling their stocks. That's one of the pressures driving the market down today, and it will mostly disappear by the end of October."

Two more reasons are based on historical evidence. One is that the majority of down markets have occurred from May to November, while the majority of up markets have occurred from November to May. So, late fall through early spring tends to be a good period to buy stocks. Plus, he hopes the stock market will continue its tradition of forecasting the economy six months in advance. "I think that we entered this recession in April, and most recessions last 12 to 14 months," he says. "If that holds true, we'll be out of this one by May, [so the market should] perk up in November."

The final factor isn't historical -- it's emotional. "I want to see everyone pessimistic," he says. "I want to see a total capitulation and a throwing up of hands. It's not until things get really bad before they will start to look good again." But measuring overall market pessimism is no exact science, so Dodson will have to depend on his instinct to determine when the capitulation has occurred. And if he doesn't feel it has happened by November, then he'll wait even longer.

SHOPPING LIST. Dodson is already thinking about what he'll buy when he does go back into the market. Although he wouldn't talk about individual stocks, he admits he's especially excited about entering the telecom sector. "We've liked telecom companies for a long time, but for the last five years or so you could never invest in them as a value investor," he says. "Now there's lots to choose from." He also expects to find bargains in other arenas of the tech sector, as well as in health care.

So far, Dodson's daring gambit has done a pretty good job of sheltering shareholders. Now all he has to do is show that his ability to invest is as keen as his ability to know when not to invest. Jaffe writes about the markets for BusinessWeek Online in our daily Street Wise column

Questions or comments? Please visit our Ask Sam Jaffe interactive forum


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