Why some portfolio managers are letting some cash go idle

Cash on hand. It's a telling gauge of what a money manager thinks of the market. In a ripsnorting bull such as we've seen this year, it's unusual to find anyone with more than 5 or 10 percent of his portfolio in cash. Every percentage point in cash is a missed opportunity for big gains.

So why are some of the savviest equity investors in the businesss sitting on portfolios with 15, 20, 40 percent idling in money-market funds or Treasury bills?

Bargain stocks are scarce.

``The value spectrum has been picked pretty clean. I haven't been able to find any new stuff to buy,'' says John Neff, manager of the Windsor Fund of the Vanguard Group, in Valley Forge, Pa. Mr. Neff's consistent record on picking winners is enough to make most money managers take on an envious emerald hue.

Neff's fund, ranked No. 15 among mutual funds for the last five years by the Lipper Analytical Services, has gone from about 1 percent cash last year to 22 percent cash now. The last time Neff had this much cash in his fund was in 1983, before a 200-point sell-off in the Dow Jones industrial average.

And consider the portfolio mix of the Baltimore-based Legg Mason Value Trust, where $10,000 invested three years ago when the fund was formed would now be worth just over $34,000. Legg Mason ranks as the No. 2 growth mutual fund during that period.

The avuncular Ernest C. Kiehne of has placed 18 percent of his portfolio in cash -- the highest level since the fund's outset.

``The market is a bit elongated,'' says Mr. Kiehne, Legg Mason's senior investment officer. ``We've had no pullback for the last year or so. And we're not finding as many stocks to buy as we would normally expect.''

Included in any list of elite equity mutual funds would be the Linder and Sequoia Funds. Their cash positions: about 40 percent.

But if -- as many predict -- this bull market is going to 2,000 on the Dow this year, perhaps 3,000 next, how can these managers expect to keep pace lugging around 20 to 40 percent in cash?

Well, they agree with the long-term prognosis of a bull market. But they don't expect the market to continue its phenomenal rise in the near term.

``The stock market is not a straight-line, upward-surging world. It's had a . . . unique performance since October. A correction seems quite inevitable,'' says Mr. Neff at Vanguard.

Large cash positions and inability to find ``bargains'' have somewhat handicapped these funds. Windsor and Legg Mason managed just to outrun the 14.1 percent rise in the Standard & Poor's index of 500 stocks in the first quarter of the year. And they lagged the Dow's 18.8 percent climb and its 50 percent 12-month rise. For the last year, Windsor gained 36 percent and Legg Mason, 40 percent. These are respectable returns, of course, but not nearly as high as they might have been had the funds been fully invested.

Neff defends his position: ``You hear the old cries: `Don't buck the trend,' `Go with the flow.' But you can't adjust [to a rally] after it ends. It takes a strong stomach to do it before the end.''

He adds that the difficulty he and other value-oriented investors are having finding bargains is indicative of an overdue correction.

Still, some wonder if the ``value'' system is outmoded.The well-respected Barton Biggs, an investment strategist at Morgan Stanley & Co., suggested recently that the value approach won't yield the best returns in the present market environment. Rather, he says, the greatest profits may lie in choosing stocks based on strong potential earnings growth.

This runs counter to the school of value-investing used by the funds mentioned above. This stock-picking system is based on the landmark book ``Security Analysis,'' written in the 1930s by a Columbia University professor, Benjamin Graham, and his assistant, David Dodd.

The method entails searching for stocks with undervalued assets that are not yet recognized by the market as a whole.

Those using Graham-Dodd to single out these stocks look for such things as a low price/earnings ratio, a strong cash flow, a solid balance sheet, a stock price that is less than book value, and a special niche in the sales market. The emphasis is on calculating the true value of assets and not relying on future growth of a company's earnings.

While bargains are scarce using this method, Kiehne is cautiously buying some depressed energy-related issues: international oils, west Texas banks.

Neff says his portfolio is already ``chockablock full of oils.'' Two-thirds of his oil stake consists of Royal Dutch Petroleum, Shell Transport, and Exxon.

The only new stock he's been able to ``nuzzle up to'' recently is International Business Machines. To do so, he had to lower his selection standards a bit. Nevertheless, he says, ``IBM represents a pretty good buy, for adrenalized [high-glamour] merchandise. It's got a 14 percent growth rate and a yield of some magnitude, and the dividend is about to go up.''

IBM stock has been hurt by expectations of lower earnings. While the Dow Jones industrial index rose about 300 points the first quarter, the price of IBM stock fell.

This past week, the Dow industrials had a decidedly negative bias that made cash look like a rather smart investment. The Dow closed at 1,739.22 on Friday, giving up 82.50 points in five trading sessions.

H'm. Students of Graham and Dodd may yet go to the head of the class.

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