Commentary

When the Dow Jones Industrial Average recently hit the 10,000 mark for the first time since last fall's market collapse, it was a potent symbol of how far the stock market has come since the lows it hit in March. Yet even with the big gains the market has put up over the past seven months, plenty of people are still nervous about the strength of the rally. There's general agreement that the recession is ending and the economy is healing, but various camps disagree over whether the recovery will be strong enough to justify the optimism baked into stock prices. While third-quarter earnings have generally been better than expected, mixed economic data have kept the market on edge.

This disagreement extends to the top mutual fund managers whom we talk to on a regular basis. Some of them are bullish about the market's near-term prospects, while others are much more cautious after the big runup. In light of this, we decided to look at all the Fund Analyst Picks in equity categories (not bond, balanced, or target-date funds) and rank them according to the percentage of cash in their most recent portfolio.

Several Analyst Picks list no cash in their most recent portfolio, the largest of which are Perkins Mid Cap Value and Columbia Value & Restructuring, and many others have less than 2% in cash. This doesn't necessarily mean that they're bullish, as some funds make it a practice to be fully invested no matter what.

On the other end of the spectrum, the following table shows the 10 equity Analyst Picks with the largest cash stakes as of their most recent portfolio, along with each fund's total return and percentile ranking in its category for the year to date (as of October 22). Funds holding a lot of cash are presumably more cautious than those that have put all their money to work, but even among the cash hoarders we found differing views of the market.

Click here to view the table. http://news.morningstar.com/articlenet/article.aspx?id=312718

For the most part, these funds tend to be cautious and valuation-sensitive (notice there are no growth funds in the bunch), and several of them are run by managers who are known for holding lots of cash. Bruce Berkowitz of Fairholme, for example, has maintained a double-digit cash stake throughout that fund's 10-year history; he has frequently had more than 20% or even 30% of the fund in cash, so its current 17% cash stake is actually pretty modest by historical standards. Berkowitz likes to "keep some powder dry" for good opportunities that might arise quickly, so he can buy them without having to sell something else first. That approach has worked very well, as the fund has been one of the most consistently strong performers out there.

Similarly, two-time Morningstar Fund Manager of the Year Bob Rodriguez of FPA Capital typically holds a big chunk of that fund in cash, more than 30% from 2006 through 2008. Like Berkowitz, he has brought that cash stake down recently, so that it's lower than it has been in years despite still being over 20%. Most of the money Rodriguez has put to work has gone into energy stocks, which made up more than half the portfolio as of September 30. That big energy weighting has helped the fund perform very well this year despite its still-large cash stake, and it also sports excellent long-term returns.

Many of the other funds here don't always hold a lot of cash, but ramped up their cash stakes in last year's crisis and have been slow to bring them down. Mutual Quest had less than 10% of its portfolio in cash from 2005 through 2007, but manager Anne Gudefin brought that cash stake up to around 30% amid last year's financial crisis. All that cash has been a big factor in the fund's poor relative performance in 2009, but Gudefin has been hesitant to commit it too quickly because of her slow and deliberate style. (The fund's cash stake did fall from 35% on June 30 to 30% on September 30.) Similarly, both Osterweis and Royce Special Equity ramped up their previously modest cash holdings in 2008; both have since invested some of that money, but remain cautious about the strength of the economic recovery. On the other hand, Wally Weitz of Weitz Hickory and Weitz Partners Value accumulated a lot of cash after selling some of his big winners in the market runup, but he has not invested it because he hasn't found good enough values to roll the proceeds into.

So to sum up, most of these managers are holding less cash than they did at the height of the market meltdown, but they're being prudent about reinvesting it, which is why their cash stakes remain high. There's a lot to be said for that kind of prudence, especially in a largely speculative rally like this one, though there are also risks in holding a lot of cash, as the poor recent performance of some of these funds illustrates. Ultimately, it's the skill and track records of these managers that give us confidence in their ability to keep varying levels of cash.

David Kathman, CFA does not own shares in any of the securities mentioned above.