What % should one hold in "dry powder"?

[jjlin]

Just wondering what (if any) rules/strategies folks have for determining how much cash one should have at the ready — especially if you start with an assumption that you're unable to correctly time the market. It seems like by varying the amount you have in cash suggests an implicit timing. Or maybe I'm missing something?

 

Thanks!

 

 

[stahleyp]

I think race did a study on this and found that the ideal cash amount was $0.

 

For most value investors, I'd say they they don't really keep much powder dry intentionally. As things get up to close to intrinsic value, they sell. If they can't find anything, then the cash builds up.

[Andy Dufresne]

stahleyp is probably correct for fully formed investors ... however, if you are starting out and your circle of competence is small plus you shirk away from large positions you might hold a lot of cash ... Pabrai at some point if I'm not mistaken held BRK in lieu of cash, but that's another discussion :)

[Laxputs]

I believe Pabrai also said for his last 10% he wants 10x his return.

[infinitee00]

I think race did a study on this and found that the ideal cash amount was $0.

 

For most value investors, I'd say they they don't really keep much powder dry intentionally. As things get up to close to intrinsic value, they sell. If they can't find anything, then the cash builds up.

 

I have yet to see the study. AFAIK he is still working on it and the study wasn't complete. Can you please post the study if you have it?

 

It would be difficult to conclude about ideal cash amounts without looking at the assumptions, sample size or methodology behind the study.

[racemize]

I think race did a study on this and found that the ideal cash amount was $0.

 

For most value investors, I'd say they they don't really keep much powder dry intentionally. As things get up to close to intrinsic value, they sell. If they can't find anything, then the cash builds up.

 

I have yet to see the study. AFAIK he is still working on it and the study wasn't complete. Can you please post the study if you have it?

 

It would be difficult to conclude about ideal cash amounts without looking at the assumptions, sample size or methodology behind the study.

 

Still working on it, it will be pretty long and I've gotten caught up in a bunch of work stuff.  The actual work of it is done, I just need to write it up and make it pretty. 

 

Jumping to the conclusion, and with the caveat that this is only with regard to holding cash as a matter of principle, or based on macro conditions, and not based on running out of ideas that meet your minimum threshold (or, in other words, I'm not arguing 100% invested all the time, just that if you have good ideas, holding cash does not appear to generally be a good strategy), the ideal cash % is 0 for most people.  If you are extremely volatile (much more than the S&P), then cash starts to make more sense.  For example, two of Pabrai's funds had ideal cash %'s > 0--no one else has that I've looked at.  Or, if the really great ideas appear often enough, and they are far, far better than your normal ideas, then it can also make sense.  That assumption is hard to test adequately, I just know where the threshold amount is, and it seems hard to justify holding cash given those thresholds. 

 

For a more exhaustive answer, I need to finish writing the essay.  I really aim to work on it diligently, soon, but it will be quite long and I take a while, since I like having these essays in very good shape before releasing them.

[peter1234]

I think race did a study on this and found that the ideal cash amount was $0.

 

For most value investors, I'd say they they don't really keep much powder dry intentionally. As things get up to close to intrinsic value, they sell. If they can't find anything, then the cash builds up.

 

I have yet to see the study. AFAIK he is still working on it and the study wasn't complete. Can you please post the study if you have it?

 

It would be difficult to conclude about ideal cash amounts without looking at the assumptions, sample size or methodology behind the study.

 

Still working on it, it will be pretty long and I've gotten caught up in a bunch of work stuff.  The actual work of it is done, I just need to write it up and make it pretty. 

 

Jumping to the conclusion, and with the caveat that this is only with regard to holding cash as a matter of principle, or based on macro conditions, and not based on running out of ideas that meet your minimum threshold (or, in other words, I'm not arguing 100% invested all the time, just that if you have good ideas, holding cash does not appear to generally be a good strategy), the ideal cash % is 0 for most people.  If you are extremely volatile (much more than the S&P), then cash starts to make more sense.  For example, two of Pabrai's funds had ideal cash %'s > 0--no one else has that I've looked at.  Or, if the really great ideas appear often enough, and they are far, far better than your normal ideas, then it can also make sense.  That assumption is hard to test adequately, I just know where the threshold amount is, and it seems hard to justify holding cash given those thresholds. 

 

For a more exhaustive answer, I need to finish writing the essay.  I really aim to work on it diligently, soon, but it will be quite long and I take a while, since I like having these essays in very good shape before releasing them.

 

Thanks for breaking the suspense. Really appreciate giving us an update and a short summary.

:)

[oddballstocks]

I like to keep 10-15% of my portfolio in cash.  This is so I have cash to buy new positions, but it's also a reflection of the fact that I hold less liquid securities.  For those who have large liquid portfolios they can always sell out of a position to buy something cheaper.  It might take me longer to sell a position, so that I don't miss a buying opportunity I have a bit of cash on the side.

 

 

[racemize]

I also want to reiterate my request to anyone who has a good reason that can be tested to hold cash.  i.e., not something that sounds reasonable on paper, but something that can be shown to produce financial outcomes better than not holding cash, assuming there are investments that meet your hurdle.

 

To be clear, I also started this experiment thinking that the outcome would show 5-10% cash was a good idea and was surprised to find that it was not, at least among the vast majority of models and tests that I performed.  I am not in this to prove that 0% is best, I just want to find the right answer.

[learner]

Racemize-

Looks like you've done a lot of research on the optimal amount of cash in the portfolio.  I was wondering if you ever understood Klarman's strategy of holding 30-40% of the portfolio in cash.  What are the boundary conditions Klarman assumes that forces him to such an asset allocation?  I think most of his investors are in it for the long term, so it cant be redemptions.  Also, if it is lack of opportunities with high enough returns, why doesnt he reduce his hurdle?

[racemize]

Racemize-

Looks like you've done a lot of research on the optimal amount of cash in the portfolio.  I was wondering if you ever understood Klarman's strategy of holding 30-40% of the portfolio in cash.  What are the boundary conditions Klarman assumes that forces him to such an asset allocation?  I think most of his investors are in it for the long term, so it cant be redemptions.  Also, if it is lack of opportunities with high enough returns, why doesnt he reduce his hurdle?

 

I have no idea.  Honestly, I find a lot of what Klarman does confusing, but he's certainly good at it.  He is also in a very different situation than what the essay is focused on--it is not really directed to people with billions of dollars of AUM with access to virtually all investment areas.  Perhaps some Klarman experts can chime in, I'd love to hear any answers.

[peter1234]

Racemize-

Looks like you've done a lot of research on the optimal amount of cash in the portfolio.  I was wondering if you ever understood Klarman's strategy of holding 30-40% of the portfolio in cash.  What are the boundary conditions Klarman assumes that forces him to such an asset allocation?  I think most of his investors are in it for the long term, so it cant be redemptions.  Also, if it is lack of opportunities with high enough returns, why doesnt he reduce his hurdle?

 

I have no idea.  Honestly, I find a lot of what Klarman does confusing, but he's certainly good at it.  He is also in a very different situation than what the essay is focused on--it is not really directed to people with billions of dollars of AUM with access to virtually all investment areas.  Perhaps some Klarman experts can chime in, I'd love to hear any answers.

 

Klarman is often misunderstood.

 

He is not an Equity investor (anymore), he is a distressed debt investor.

 

Distressed debt is very cyclical.

 

He likes to buy (distressed) assets at 50% and less.

 

I do not think that the individual investor will be able to profit from his esoteric/institutional picks.

 

We can learn a lot from his speeches, writings, philosophy, we just cannot emulate his positions.

 

;)

 

[Patmo]

Racemize-

Looks like you've done a lot of research on the optimal amount of cash in the portfolio.  I was wondering if you ever understood Klarman's strategy of holding 30-40% of the portfolio in cash.  What are the boundary conditions Klarman assumes that forces him to such an asset allocation?  I think most of his investors are in it for the long term, so it cant be redemptions.  Also, if it is lack of opportunities with high enough returns, why doesnt he reduce his hurdle?

 

I have no idea.  Honestly, I find a lot of what Klarman does confusing, but he's certainly good at it.  He is also in a very different situation than what the essay is focused on--it is not really directed to people with billions of dollars of AUM with access to virtually all investment areas.  Perhaps some Klarman experts can chime in, I'd love to hear any answers.

 

Klarman is often misunderstood.

 

He is not an Equity investor (anymore), he is a distressed debt investor.

 

Distressed debt is very cyclical.

 

He likes to buy (distressed) assets at 50% and less.

 

I do not think that the individual investor will be able to profit from his esoteric/institutional picks.

 

We can learn a lot from his speeches, writings, philosophy, we just cannot emulate his positions.

 

;)

 

Baupost has branches in everything, including public equity...

[peter1234]

Racemize-

Looks like you've done a lot of research on the optimal amount of cash in the portfolio.  I was wondering if you ever understood Klarman's strategy of holding 30-40% of the portfolio in cash.  What are the boundary conditions Klarman assumes that forces him to such an asset allocation?  I think most of his investors are in it for the long term, so it cant be redemptions.  Also, if it is lack of opportunities with high enough returns, why doesnt he reduce his hurdle?

 

I have no idea.  Honestly, I find a lot of what Klarman does confusing, but he's certainly good at it.  He is also in a very different situation than what the essay is focused on--it is not really directed to people with billions of dollars of AUM with access to virtually all investment areas.  Perhaps some Klarman experts can chime in, I'd love to hear any answers.

 

Klarman is often misunderstood.

 

He is not an Equity investor (anymore), he is a distressed debt investor.

 

Distressed debt is very cyclical.

 

He likes to buy (distressed) assets at 50% and less.

 

I do not think that the individual investor will be able to profit from his esoteric/institutional picks.

 

We can learn a lot from his speeches, writings, philosophy, we just cannot emulate his positions.

 

;)

 

Baupost has branches in everything, including public equity...

 

Agreed, but if you look at the major allocations, they are usually heavily backed by assets.

 

He likes claims that are more senior than equity much better.

[SharperDingaan]

Couple of cautions ...

 

Testing against fund filings. The business case only requires cash for liquidity & the daily sale/redemption of units -  if the fund positions cannot be margined against. ie: ongoing cash positions should be minimal, & preferably negative. If there's a big ongoing & positive cash balance, it is evidence of investor over-contribution.

 

Cash as strategy. To hold excess cash in a fund or corporate is to hold a war chest, on the theory that the war lord will make more with it - than you the investor will, through a return of that capital via a buy-back, or dividend. Problem is; war lords also like to fight for glory, they have YOUR money, & are disinclined to give it back. When you can only buy or sell, war lords cant be part of the sample.

 

Institutional vs private. Institutional cash holdings reflect investment policy & the application of current corporate finance theory. Private cash holdings are far less restrictive & liquidity will almost always reflect a bar-bell approach that includes ability to margin, marketability, & access to cash - including money-laundering (ie: recent Vatican related incidents).

 

Funds flow. Balance Sheet cash is only required if forecast outflows are expected to exceed inflows. Problem is; it also applies if debt maturities suddenly cannot be refinanced, or if credit lines are suddenly reduced or revoked. WEBs investments in both GE and GS were the direct result of institutional lapses in this basic concept.

 

BS adjustments. War chests are not stored as cash; they are stored as low debt/equity ratios & a relatively low level of marketable securities. To get to the 'real' cash position - rerate at the industry debt/equity ratio, & add the difference to the cash balance shown on the BS. Real war lords don't need to advertise.

 

SD

 

 

[Guest notorious546]

Some of the key points from the slides on Mohnish's portfolio strategy since 2009:

 

• Do not invest in anything that does not look like a 2-3x in 2-3 years.

• If a stock trades at 10, it is a pass if intrinsic value is 13 or 14 or 17 or even 19.

• There are 50,000+ publicly-traded business around the globe…You just need to find 2-4 annually that meet this criteria.

• 1st 75% of cash – minimum 2x in 2-3 years

• Next 10% of cash – minimum 3x in 2-3 years

• Next 5% of cash – minimum 4x in 2-3 years

• Next 5% of cash – minimum 5x in 2-3 years

• Last 5% of cash – more than 5x in 2-3 years

 

http://www.valueinvestingworld.com/2013/03/mohnish-pabrai-columbia-compounding.html