Sunday, July 14, 2013

Does Money Make the World Go Around?

Many of us are familiar with the song that begins “Money makes the world go round.” As a card carrying CFA® charterholder and a recovering numbers cruncher, I will warrant that is how all too many measure the rotations of an individual’s, a business’s or a nation’s rise and fall through periods of net accumulations and net spending. However, strange for a numbers addict to say, I believe it is an incomplete and in many ways a faulty measure, particularly when considering investments.


Money is an instrument of exchange used in buying and selling. In the modern world, money is expressed in terms of different currencies that can be transmitted physically over a sales counter or electronically through a banking system. As these exchanges are most often impersonal and rapid, we use numerical shorthand to represent the terms of exchange.

Money buys goods, services, and the time of others + what?

When we make purchases of physical goods most of us think in terms of the item; e.g., an auto or laptop. We do not consciously think of the hours and talents that went into producing it. We are somewhat more conscious of the hours and the credentialed talents when we purchase services from doctors, lawyers, accountants and perhaps paid speakers. We need to include into that list paid workers such as plumbers, electricians, and landscapers. One can easily put an immediate numerical value on a number of goods and services, particularly if there are competitors. However, most of what we buy today is not only for immediate consumption. Thus, there is an implied belief that the buyer is purchasing the goodwill of the vendor, but not in an accounting sense. The value of this goodwill is not just after warranties but entails the quality and quantity of thinking and effort that can make us better users of our purchases. The advertising industry has taught us that various purchases have an emotional benefit, like making us feel good about ourselves. This combination of goodwill purchased and the benefit of us feeling better are difficult to measure and can in the long-run be more important to us than initial price paid. I would suggest that these considerations make the valuation of cash more difficult than a bookkeeping exercise.

Cash/currency in your investment portfolio

I have just completed a couple days of visiting Portfolio Managers of different funds in accounts that we manage for both institutional and wealthy individual investors. In some respects the most revealing parts of these discussions were about the smallest part of their portfolios, the cash on their balance sheets. The different comments are as follows:

  • “Cash is a residual after I make all the investments that should be made.”
  • “Cash is awaiting a few more investments that are out of price range or are not fully identified or more analytical work is needed.”
  • “Cash is a way to express a view as to the level of the market.”
  • “Cash is flow management device.”
  • “Foreign cash is a hedge against home currency.”
  • “Cash is awaiting a planned sizeable redemption.”
  • “Substantial cash holdings allow for riskier other holdings.”
I am sure as I talk with other portfolio managers I will learn of other points of view.

How do I use cash?

As indicated in earlier posts, I view my portfolio construction skills as more of an artist than a mechanical contractor. Carrying the analogy further I hope to be building estates, academic facilities, research labs, performance venues, medical facilities among other worthwhile activities. As each account is managed to meet different needs, my use of cash is far from uniform. The rhythm and timing of the account as well as the feelings about money are taken into consideration.

I use cash in a similar fashion as those that are listed above. Additionally, in risk adverse smaller balanced accounts I have used Treasury money market funds to avoid any principal loss. Currently, I am reducing this element in favor of ultra-short (duration) government funds and some short-term TIPS. My general attitude is that my clients should take their risk in the large equity portions of their portfolios not in fixed income.

If cash is trash as bulls believe, try ETFs

If I am a portfolio construction artist, the ultimate mechanically constructed investment product is the Exchange Traded Fund (ETF). One of the many reasons I believe actively managed portfolios should be compared only with other actively managed portfolios doing the same thing is as seen from the discussion above; i.e., active managers have varying amounts of cash in their portfolios. ETFs are designed to replicate the performance of a fixed list of securities. The list does not include any cash. Thus in a rising market all of the securities within an ETF portfolio could be rising in price. In an actively managed portfolio only the actively traded securities have the opportunity to rise (and fall), the cash is only a very small amount of income. Thus there is a tactical advantage in favor of ETFs. My clients believe that well-chosen selected investments will produce better strategic results.

What does your use of cash say about you?
Please share with me privately or publicly.

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