By ROGER LOWENSTEIN
Do you know why fund managers rush to pick up the check at lunch? They are desperate to get the green stuff out of their wallets; they are in dread of holding cash.
They used to carry a little around as a keepsake or, if they resided on Wall Street, to provide for a sudden out-of-town-departure, but now that E-Z Pass has come to the George Washington Bridge, even their toll money is going into stocks.
Why they feel this way is plain. Cash isn't part of the Standard & Poor's 500; it doesn't have a multiple. When you hold cash, investors and consultants want to know why you haven't bought General Electric instead. But managers who rule it out are, in fact, abdicating an important part of their job.
Fund managers commonly say that by holding cash they would be subverting the wishes of their shareholders, who "gave them the money to put in stocks." Others protest that they are not "market timers." At Dreyfus, a spokeswoman says, "We believe it is our responsibility to put our shareholders' money to work." As goes Dreyfus, so goes the nation.
There is no call for market timing here. But the market could use a few more Edwin Walczaks.
Mr. Walczak runs the Vontobel U.S. Value Fund. Its biggest holding is "cash," some 35% of the fund. Its name notwithstanding, Vontobel is by no means insensitive to the appeal of growing companies, nor is it averse to high price-earnings ratios. Mr. Walczak has owned Gillette; he has owned Coca-Cola.
Nor is his record a cause for shame. The fund was begun just before the last bear market, which only feels like three centuries ago (it was 1990). Through 1996, and despite often-high levels of cash, it was ahead of the S&P. But in 1997, its cash position soared. As of midyear, Vontobel sports a lifetime return of 16.25% a year, a percentage point behind the S&P. It leads most of its competitors.
However, on Wall Street, Mr. Walczak is the freak in the circus. As his cash swelled, Morningstar ripped off one of his five stars, and investors have started to withdraw. The fund, which is scantily advertised, has only $100 million. (Mr. Walczak manages more in private accounts.)
Mr. Walczak is not making a market bet, as I think ex-Magellan Fund boss Jeff Vinik was. But for a stock to seduce Mr. Walczak away from cash, he must expect that stock, in rising to fair value, will surpass, and comfortably surpass, the risk-free return on the 30-year bond. That's the minimum hurdle.
Mr. Walczak's, and our, all-seasons measure of value is estimated future free cash flow, discounted back to the present. For the best businesses -- he looks for companies with predictable earnings and an ability to reinvest profits at high rates of return -- he is willing to forecast growth some 10, even 15 years into the future. He is unwilling to forecast growth forever. In the past year, many of the stocks he owns have risen to the point where bond-type returns are all that is left. Many managers have concluded similar of their stocks, but Mr. Walczak has sold them. Bye-bye Gillette, adios Coca-Cola, adieu, Torchmark.
The 19 stocks he owns, such as Cincinnati Financial and Knight-Ridder, are up big time, but they are too well along in the range of fair value to justify further purchase. The point is, he holds cash as a result of a bottom-up, disciplined search for superior investments that has lately come up dry.
Most managers act as though they are hired to pick the best relative values. If you buy the mining fund, you get the best mining stocks regardless of whether any are worth a darn (that's why I'll never own a mining fund). If you buy a general equity fund, you'll get the best equities, also regardless. Managers overly sensitive to holding cash thus compromise their standards. According to Donald Hall, who runs Scudder Value, "The individual has made an asset allocation decision. You just have to raise your sights as the market goes on."
Mr. Hall's fund has five stars. But the decision to "allocate" should not be made independent of values. You cannot -- should not -- decide to buy stocks until you have found some you like, some that, conservatively forecast, will handily beat the return on cash.
A small investor in particular cannot expect to be skilled at making a broad asset allocation -- only Jeff Vinik can do that. But a fund that is ever and always fully invested leaves to the investor the burden of allocating his cash -- that is the burden of deciding whether to sell. Mr. Walczak relieves him of the burden; he says, in effect, "You don't have to worry about the market; if I can't find sensible stocks I won't be in the market."
It is possible that Mr. Walczak is too choosy, but if he lets the market substitute its judgment for his, why be in business? It is possible that he will be left behind. "But what are we supposed to do," he asks, "violate our discipline?"