Cash is a Position

(If Used Strategically)

I’m revisiting a post from the early days of this newsletter that many of you may have missed. It explores the role of cash and its merits within a portfolio. I highly recommend giving it a read to better understand how I view cash as a strategic position.

For all readers a reminder that taking on board the feedback from the Six Sigma Research poll, I have extended a one time discount on the annual membership which expires at the end of the month (long term games with long term people).

This saves approximately 30% compared to the monthly rate and is more than 45% cheaper than the Substack app price.

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Modern Portfolio Theory teaches that Cash or cash-equivalents like Treasury bills are the risk-free asset against which all other assets should be compared. Cash offers low volatility and a known rate of return. Currently cash offers around 4.5% return. In a portfolio cash is a strategic tool one can use to increase or reduce risk.

My approach re a cash position over the years

For the longest time, I stayed 100% invested and added outside capital as needed. Ergo cash position was often 0% and if I had exited a position it immediately went to another position in the portfolio. However, for the last few years the cash position has been fluctuating based on whether the market is overbought +/- overvalued or very oversold +/- undervalued. The simple idea being to raise cash when stocks are extended and sentiment is hot and to reduce the cash by allocating to assets when the perceived risk-reward is strongly in my favour.

We know that cash is safe short-term but risky long-term due to inflation. Also, a hefty cash position could be a drag on returns i.e. a “cash drag”. On the other hand, in an uncertain market Cash is a call option on future opportunities. Furthermore, in the case of drawdowns it will reduce the size of those drawdowns due to cash being unaffected (excluding FX impacts). The maths is quite simple: if one is 50% cash and the portfolio holdings collectively fell 20% then instead of a 20% drawdown, one’s drawdown would only be 10%. Simultaneously, the held cash could be used to purchase assets at much better valuations. Trump markets have been notoriously volatile and hence a decent cash position may not be the worst idea…

My very recent approach to cash has been the following:

By late January I was ~25% cash. This was after exiting Tesla around the end of the year at 420.69, profit taking in BABA and HIMS especially (as it ran parabolic) plus exiting some opportunistic trades, some of which were losers like FSLY and TDOC.

By the time volatility returned to the markets in late Feb, I slowly started adding but the bulk of the buying came between April 4th and April 11th. I went from 25% to 0.1% cash by Friday 11th April. I wrote extensively on twitter at this time including the stocks I had selected to accumulate which were: AMZN GOOGL MSFT UBER JD.L PDD HOOD and HIMS. My instinct to invest at this time came due to sentiment and positioning being so overwhelmingly bearish meanwhile understanding that the driver of this action was a self-inflicted wound by the President. I surmised a resolution pended. Furthermore, major indices such as the Nasdaq Composite for example were testing long term support levels as seen in chart below.

1 month later the same chart shows it did serve as support and we are now at ~19.2k.

Nasdaq has rebounded more than 30% in that time and I am now at 24% cash after booking some of the quick gains plus exited CELH, UBER, WING completely (for >50%, 40% returns and 35% respectively)

I anticipate volatility ahead hence will be maintaining a larger cash position. This will not only free up cash but also preserve mental capital. So, that is what I have been doing but let’s look at the approach investing legends have taken when it comes to cash positions.

Warren Buffett and Charlie Munger

Berkshire currently have $347.7 billion in cash relative to the their market cap which is $885B. That cash position has continued to swell and when asked about it Buffett has indicated that the substantial cash pile reflects caution due to “elevated market valuations’“, suggesting a lack of attractive investment opportunities at current prices. He is maintaining a conservative approach, holding safe assets like Treasury bills to ensure liquidity and security. The phrase “better a little caution than a great regret” comes to mind!

Buffett’s long term partner Charlie Munger also advocated for “sitting on your ass and waiting for fat pitches” so in essence a high cash position is not necessarily market timing but rather preparedness for when obvious big opportunities arrive aka the ‘fat pitch’.

Stanley Druckenmiller

Druck’s approach to a cash position is dynamic and depends on his macroeconomic outlook plus the availability of high-conviction investment opportunities. He is known to be a concentrated investor and bet big when needed or conversely go up to a 100% cash if he has a bearish outlook on the markets. Interestingly, Druck has stated in the past that when having a good year, one should “step on the pedal“ rather than prematurely booking profits and moving to cash. Of relevance to me, I am having a decent year and gone to 24% cash to be defensive given the backdrop but the above has me reflecting whether my cash position could be too high given markets appear to be strong. Also, instead of diversifying or making low conviction-bets just to be invested, Druck states he would rather have cash.

Paul Tudor Jones

PTJ is one of my investing idols and I especially align with how much emphasis he puts on Capital preservation or as he puts it “Don’t lose Money”.

He famously said in the Market Wizards series” “The most important rule of trading is to play great defense, not great offense. Every day I assume every position I have is wrong. I know where my stop risk points are going to be. I do that so I can define my maximum possible drawdown. Hopefully, I spend the rest of the day enjoying positions that are going in my direction. If they are going against me, then I have a game plan for getting out.” This is a quote I read regularly and helps me to be more diligent with risk management.

Tudor Jones also pays close attention to central bank policies and their impact on inflation and asset prices. If he anticipates monetary tightening or raised inflation he will raise cash levels.

In short, Paul Tudor Jones utilises cash as a risk management tool. It allows him to reduce potential losses, maintain the flexibility to seize opportunities, and navigate volatile periods whilst preserving his capital.

David Gardner

David Gardner, who is the co-founder of The Motley Fool and advocates for “Rule Breaker” investment philosophy, has stated to”stay 100% invested your whole life long”. In his approach he advises to stay fully invested in the stock market, especially in innovative, growth-oriented companies, for the long term.

So what cash position should you have? In truth there is no perfect answer because it depends on ones individual needs, risk profile and their assessment of prevailing market conditions. Of course, my current cash position is relatively high because of expected heightened market volatility, geopolitical uncertainty and asset valuations being stretched.

I will leave you with this quote by Paul Tudor Jones:

“Cash is worthless, so what do you do with your money? Well, there’s a time when to hold em and a time when to fold em…You’re not going to necessarily always be in situation to make a lot of money, where the opportunities are great.”

When the opportunities are great, I will be all-in again.

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