Monday, July 27, 2009 0 comments ++[ CLICK TO COMMENT ]++

Should we favour those who hold high amounts of cash?

The post where I was speculating on Seth Klarman's performance generated a lot of interest. A lot of it was due to the excellent blog, Distressed Debt Investing, picking up the post. Everyone has their own view on performance evaluation—some don't even think you can compare performance—but I want to address one point that was raised by several people. It has to do with Klarman holding high levels of cash.

Several people feel that Klarman should be looked upon more favourably because he holds high levels of cash. What do the rest of you think? Is Klarman being handicapped by his cash levels? My answer, which is strictly my opinion, will probably be controversial.

My view is that I would not give a bonus to Klarman just because he holds cash. The way I look at it, what matters in the end is the actual performance. If you were risk-averse, you may value cash but I personally don't. If one used debt, then I would be a bit wary but it depends on the levels.

Holding cash will be drag on your performance when times are good. So, yes, Klarman's performance was dragged down by his cash during the booming 90's. However, one should also realize that holding high cash improves your performance when times are bad. Klarman would have got a huge boost, relative to the broad markets, during sell-offs. Given the massive crashes, he would automatically get a relative boost from 2000-2002 and 2007-2009.

So, to sum up, the argument that Klarman was better than his numbers indicate because he holds sizeable cash positions is not a strong one in my eye. The drag during good times is cancelled out by the benefit during sell-offs. Klarman is still one of the best investors out there but if his performance is dragged down by high cash levels, it's a strategy he is following on purpose.


BTW, I have typically held 20% to 50% cash in my small portfolio in the last 2 or 3 years—I don't measure performance with the cash so my performance is overstated in good times and understated in bad times—so it's not as if I'm against the strategy. All I'm saying is that one should not suggest that this is somehow better than it seems. I think of it as something that cancels out in the long run.


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