racemize

Then, please, answer the question I asked anders just a few posts ago... Gio The answer is obvious and he already gave it to you. The point is that your initial post and how it's written suggests that you positioned yourself for a crash by having a high cash allocation and limiting your spectrum of investments as opposed to allocating cash "naturally". I would argue that I have no idea whether we are in 1996 or 1999. For all I know the market could start a 30% slide tomorrow because [reasons that will be apparent only after the fact] or keep going for years. As long as there are compelling opportunities you should seize them and avoid forming a strong opinion about the market (à la Hussman) which can put a big part of your capital on the sidelines for a long time. Agree completely.

Can't really address alternate histories. I'm just seeing if using these metrics could be used to outperform the market using actual events, over a long time-period.

So, as far as I can tell, this just indicates a lower expected return at high ratios and higher expected return at low ratios, which is the same thing that CAPE predicts. However, that doesn't mean that one can outperform the market by sitting out when the expected return is lower and getting in when it is higher. I'm looking for someone showing that you can actually outperform the market versus staying 100% invested by using whatever metric. That's the evidence I'm looking for, and without it, I don't really understand relying on these metrics other than getting your expectations right for what the market may return. E.g., I agree these metrics are all high right now, and don't expect a lot out of the market going forward, but that doesn't mean that going to cash based on that expectation will actually afford me higher results. That was why I started working on the aforementioned essay.

I haven't seen any. Can you show me a study that uses market cap to GNP to determine when to stay in the market and get out that outperforms? e.g., CAPE is predictive of future returns, but it does not appear to be usable, a priori to outperform the market. So my point is, if no one can show that whatever metric they are using to justify holding cash actually outperforms, then it is not a valid basis for holding cash. I'm happy to be proven wrong here, but I haven't seen any evidence to the contrary. Moreover, if it can be done based on something basic (e.g., GNP ratio, CAPE, P/E, etc.), then everyone should be doing it to outperform the market, right? That is just the sort of thing that would be arbitraged out of the market, because it is too easy to do. Basically, all these arguments come down to "timing the market" which is incredibly hard to do. I used Shiller's data from 1871-current, to avoid issues related to specific time period. For example, there are studies that I reproduced that worked in their sample period (e.g., 1970-2001), but not out of sample. I'm basing my statements on historical studies, not my personal history. I think if you read the essay you'll see what I'm saying. However, to answer your question directly, I've been investing since 2010, and I would fully agree that if my statements were based on that period, it should not be trusted, but that's not where I base my conclusions from.

One thing to note with Marks--he is required to be fully invested. When he talks about the pendulum and the corresponding amount of aggression he uses, he's talking about being conservative or aggressive with the hurdle and/or assumptions being made, not holding cash. I think such a strategy makes a lot of sense (i.e., more conservative assumptions for specific investments as the pendulum moves toward greed). With regard to using it for cash holding purposes, it sounds perfectly reasonable. The problem I have, however, is that many ideas that are "reasonable" (e.g., using CAPE or other valuation metrics to move in and out of the market) are not supported by evidence in producing superior long-term results. Basically, I'm taking the stance that there should be compelling evidence to use any particular strategy. I feel like many of us use superstitions and gut feelings for a lot of this area of investing, which I'm not comfortable with, personally. I don't think Marks is required to be fully invested whatsoever - that goes against everything I've ever heard about his firm and his style. Their most recent fund was specifically raised with a view towards the next default cycle. I'm sure they might have some product that is fully invested, but I am almost certain that's not true at all for the vast majority of their assets. Well, I watched an interview with him where he stated what I just said above--that when money is raised it must be fully invested. I guess it is possible that he was referring to something in particular, but it didn't seem like it. Perhaps he means it has to be fully invested when called.

One thing to note with Marks--he is required to be fully invested. When he talks about the pendulum and the corresponding amount of aggression he uses, he's talking about being conservative or aggressive with the hurdle and/or assumptions being made, not holding cash. I think such a strategy makes a lot of sense (i.e., more conservative assumptions for specific investments as the pendulum moves toward greed). With regard to using it for cash holding purposes, it sounds perfectly reasonable. The problem I have, however, is that many ideas that are "reasonable" (e.g., using CAPE or other valuation metrics to move in and out of the market) are not supported by evidence in producing superior long-term results. Basically, I'm taking the stance that there should be compelling evidence to use any particular strategy. I feel like many of us use superstitions and gut feelings for a lot of this area of investing, which I'm not comfortable with, personally.

I don't view it as confidence, or any commentary on the market at all. I like the stocks I own, and would continue to buy many of them if I had more cash. I don't think I'm smart enough to make any calls on the market as a whole, so I'm just sticking with whether I think my stocks are cheap or not. I fully expect to be wrong on many of my picks. Hopefully, I'm more right than wrong, however. race, is that the same for retirement accounts (I'm referring to ones in which you can't buy individual securities)? Oh, I just dollar cost average and don't think about it. I'm also in value funds, so I let them make the decision re cash themselves. I do not think I have the ability to time the market, and am highly doubtful very many people in the world can.

I don't view it as confidence, or any commentary on the market at all. I like the stocks I own, and would continue to buy many of them if I had more cash. I don't think I'm smart enough to make any calls on the market as a whole, so I'm just sticking with whether I think my stocks are cheap or not. I fully expect to be wrong on many of my picks. Hopefully, I'm more right than wrong, however.

fully invested. I wrote an essay on this posted elsewhere, if you are interested.

I did not assume the cash was invested in bonds. A primary reason is because the cash needed to be available for investing in equities and I didn't want to have exposure to interest rate risk. Additionally, I don't ever buy bonds with my cash, so I just wanted to see what would happen on the equity side only. Do you have a paper for the 60/40 stock/bond portfolio? Usually they report the same risk adjusted returns, but not the same actual returns. I'm not a huge fan of "risk adjusted" returns, particularly over long term investments. As Marks would say, you can't eat risk adjusted returns...

I can't speak for Racemize, but the way I understood it, some people target a certain % of cash "just in case" some big huge fat pitch comes along, because they believe that having the cash to jump on these infrequent opportunities makes up for the drag that the cash creates the rest of the time. So they might have a hurdle of 15% and invest in whatever they can find that meets that, but they keep an extra 20% cash on hand waiting for "blood in the streets" scenarios, even if they could use that 20% to just buy more of what they have in the other 80% of their portfolio, or similar things. I'll just nominate Liberty as my spokesman. Yes, this was the purpose of testing the hypothetical portfolios, and then testing the real portfolios to confirm with live results. The other test I was doing was regarding general market timing/market overvaluation chatter for holding more cash. I lean more and more to Howard Marks philosophy--being offensive when there is disconfidence (is that a word?) and defensive when there is confidence. In his case, he is required to deploy the capital (or at least he has said that), so it isn't a matter of holding cash, but how aggressive he is on investments that he makes. Further, since we do not have to deploy cash to poor ideas, we can let the ideas determine the cash levels rather than any other factors.

I guess I agree with the younger age bit, but I tend to not care what the age is--I'm just focused on maximizing returns, regardless of age. So, in that sense, if leverage makes sense, then I'm for it. But I think it crucially depends on how volatile your portfolio is/will be, and that is very hard to know. For example, if you hit a 60% downturn like Pabrai did in 2009, then it could be potentially devastating. I like the idea of using margin for the extraordinary opportunities. e.g., staying mostly invested all the time, and if 2009 hits (or broad down-turns), using the margin at that time. Or similar, but low levels of margin in ordinary times (e.g., say 10%). I think I would hesitate to have normal levels of margin at 30-40%. But I haven't tested this to be sure. I also think this is very hard to test well to come to any solid conclusions about what levels of margin should be held though. Addendum: I think Packer has given this more thought than I have, so it might be good to ask him, or see if he feels like pitching in his thoughts.

Hey guys, thanks for all the discussion and comments! So with regard to the purpose of the essay, I tried to lay it out a bit in the first paragraph, but perhaps didn't do a great job of it. In essence, I've had a lot of discussion with people on the board about when and how they hold cash, and I wanted to know which were supported by data and which were not in terms of superior long-term results, so I started testing. Here are some of the strategies that I ran into: 1) Stay fully invested all the time (e.g., Packer, stock screening methods, etc.). 2) Ignore the macro, and focus on individual investments. Accordingly, invest when opportunities meet your hurdle and don't when they do not (I believe this is what Buffett believes and says repeatedly). 3) Pay attention to the macro and hold cash when things seem "heated", because when large stock corrections occur, all of your value investments will as well. This has a lot of different aspects, such as paying attention to general stock market P/Es, CAPE, corporate margins, Stock market/GDP, etc. Gio and I have gone back and forth quite a bit on this, and I'm sure he can provide a lot of investors that are on board with this concept. It was this investing style versus 2) above that I wanted to answer, primarily. The way that made sense to me to do it was the following: a) under the assumption that one could accurately catch the bottoms, determine whether or not outperformance was possible, but having the opportunity cost of holding cash in your portfolio outside of the bottoms, which was the first section of the essay and b) determine if market valuation metrics, and particularly CAPE (since it is more correlated with future returns than P/E is), could be used to identify how much cash to hold. Basically, my point of view is, if you rely on a metric (such as CAPE) to make decisions about cash, then it should be predictive, and if not, should basically be ignored for that purpose. I was just trying to see what the data supported. I also went and looked up as many "outperforming" papers that I could find, and then test the ones that seemed to make sense and weren't based on hindsight data analysis. One of the best ones was based on the spread between bonds and stocks, which I included in the essay. I did not find any outperformance models that worked outside of sample, in a large historical context. 4) Pabrai's method, where the hurdle for each subsequent level of cash increases in order to ensure that each marginal dollar is used for progressively better investments. I asked him about this, particularly whether or not it worked and how often these big events had to happen in order to result in outperformance versus his previous method. He was short of time as it was at the FFH meeting, but essentially told me "well, you'd need to do the math". So I attempted to test that with the hypothetical models. And finally, I thought it would be interesting to just take actual portfolios and back test to see if holding cash ever made sense (which is related to item 4). i.e., if holding cash for downturns would yield higher results. So, I wasn't ever really trying to approach the problem of comparing 1) or 2), but addressing 3/4 versus 2). Basically, just comparing if holding cash outside of investment criteria made sense. I think it is more difficult to make the leap that 1) is better than 2), but it is certainly possible. The problem with 2) versus 1) is that it depends on the skill of the investor and the opportunities that arise, so is hard to test in any real sense. That same criticism can be applied to my testing of 4), since the answer depends on how reliably one can identify the large opportunities. If they can be found consistently, then holding cash for them makes sense. Hopefully that all made sense, I need to go eat breakfast!

Thanks for your kind words. I don't care too much about publishing it officially--I just enjoy working on these essays and am happy to make them available to whoever is interested. I worked on the calculations with some other people to make sure I was doing it right and spent a lot of time on them, but I don't mind further verification if people are interested in looking at it and/or doing more tests. Most of the calculations are just done in big google spreadsheets.

Thanks Liberty. Regarding leverage, I haven't done a lot of actual testing, but I've been thinking about how it might work, given the testing I've done. And I think the answer is that leverage is generally good to use, but you can't ever get margin called, as that is highly destructive. So, it will come down to how volatile your portfolio is (which is similar to what this essay comes down to). Thus, if you are very volatile, no leverage is likely best (and perhaps holding cash routinely as well). But if you are less volatile, then some leverage is good. So I tend to think that some leverage is probably warranted for the best long term results, assuming a long-enough time period. Again though, I haven't done a lot of testing to be sure about that line of thinking. Perhaps I should make it a follow-on essay...

I used the percentile that it was, which in those years I think was 100%. I just re-ran it with a 50% limit, and got a CAGR of 6.53% before tax and 5.28% after, so still not better than fully invested, but better than 100% bailing. Or re-running it compressing the results to between 0.5 and 1 gives 7.39% and 6.01%, respectively (also underperforming). These spread experiments came from an academic paper that did have outperformance from 1970-2001 (and also in my own tests from 1970-2014), so I was mostly testing them to see if they worked over a longer historical period, that didn't largely sample the huge bull run to 2000. In any event, they did full investment or not based on that. I didn't do any testing to see if it would work with partial numbers (e.g., 50% instead of 0). I just ran 0.5 instead of 0, and it is better, but not better than 100% invested. No worries, I tested quite a bit more while I was messing with it, and the tests I showed aren't all the possible ones. Certainly there are other possible models and tests, but essentially nothing I found would work, so it didn't seem like there are any easy answers, at least (which again, should not be surprising--easy answers should be arbitraged out). Thanks!

Hi All, I've finally finished writing and revising my essay on holding cash in a portfolio. Several of you have asked about it over the last few months (which was flattering by the way), and I'm sorry it took me so long to get it out. This year has been incredibly eventful for me, so I didn't get to devote the time needed to finish this until recently. In any event, I hope it is useful to board members. https://www.dropbox.com/s/96hwafdp5egf460/2014-15%20Why%20Hold%20Cash.pdf?dl=0

Is there a place where the letter to shareholders in the print-out can be found online? I didn't see it in the 10-K.

I saw a lot of notes being taken down, so I'm hoping someone will have a nice set typed up, similar to last year.

I'd be interested in a lunch afterwards.

That is not my understanding, at least for your main home: http://www.irs.gov/taxtopics/tc701.html

turnover on mutual fund indexes generate taxes in general (e.g., 4% turnover), but for the last 10 years, they've managed to avoid any taxables due to inflows, is my understanding. I'm not sure if that is true for ETFs though. This is from an article I found on it:

These are good articles, I wish I had read them before I wrote my own essays on the same topic! Here are mine, if you are interested. They say very similar things to the articles, but I think mine have a bit more data and hypotheticals (but of course, I'm biased). https://www.dropbox.com/s/8om0k5hmvudz58a/2013-09-22%20Holding%20Period%20Essay.pdf?dl=0 https://www.dropbox.com/s/uwawteaj86zfz1l/2014-03-25%20Hurdle%20for%20Active%20Investors.pdf?dl=0

I think Marchionne has similar feelings, given comments on the Fiat conference calls.

I would not characterize BAC as "low cost", other than cost of deposits.