Managers Have Little Cash for Bargain Hunting

Tuesday’s dramatic sell-off and the months-long correction in many U.S. stocks have certainly created more “buying opportunities” in the domestic equity markets, especially among small and medium-sized companies, mutual fund managers say.

But questions remain as to how quickly value hunters will leap into these supposed bargains.

For starters, there’s the problem of cash.

“Unless you have a very large cash position, you have to wonder where you’re going to get the money to buy these ‘raving buys,’ ” said Jim Stratton, manager of the Stratton Growth Fund.

Today, the typical domestic equity fund has less than 5% of its assets in cash reserves. That’s about as low as it’s been in 20 years.

The picture is even bleaker among small-company funds, which, theoretically, are poised to find the biggest bargains. Small stocks, pummeled in this market pullback, now trade at price-to-earnings ratios (based on 1999 estimated earnings) nearly 20% below blue-chips’ P/Es, on average, according to Schroder & Co. emerging-growth strategist Dan Coker.

Yet in June, aggressive-growth funds, the closest proxy to small-cap portfolios, were holding only 4% of their assets in cash, according to the Investment Company Institute, a trade group in Washington. That’s down nearly by half from the 7.2% level of April 1996.

At the same time, investors aren’t replenishing the cash in these funds.

The ICI reports that only a net $9.2 billion flowed into aggressive-growth funds this year through the end of June, the latest figures available, as most investors shy away from small caps.

That’s off about 23% from the same period a year ago. By comparison, a net $41.4 billion flowed into growth funds in the year’s first half and $47.9 billion flowed into growth-and-income portfolios, which favor blue chips.

What does this mean?

Small-cap portfolio managers will have to expend what little cash they have to buy on this dip, putting themselves at risk should shareholders redeem their accounts in greater numbers in the coming weeks.

Or they’ll have to do what Jim Stratton is doing: sell some of what they have--and still like--to get what they want more. In recent days, Stratton sold a portion of his holdings in Lincoln National, a life insurer, to buy Safeco and Ohio Casualty shares, which have been battered but which he considers values.

He took this course even though his fund currently holds 10% of its assets in cash.

“I’m not certain this is over,” Stratton said. “As a result, I don’t want to commit my cash.”

He thinks other managers will behave similarly, which could delay a market recovery.

If there is significant buying on this dip, the same attitude that led a generation of fund managers to believe that “cash is trash” could lead to irresponsible bargain hunting, warns Jean-Marie Eveillard, manager of the SoGen International fund, which invests in domestic and foreign stocks as well as bonds and other assets.

“People are saying there are all these great opportunities to buy now,” he said. “But I’m not sure [this decline] in the market creates vast opportunities.”

Still, he thinks some managers, especially younger ones who have never been through a true bear market, may be moved to buy immediately.

“Over the past few years, every decline has been an opportunity to buy--with the benefit of hindsight,” he said. “It’s like a Pavlovian reaction.”

While Robert Boyd, manager of the UAM ICM Equity fund, believes there are “extraordinary opportunities in the small- and mid-cap universe,” he fears careless managers might confuse true bargains with once-lofty stocks that now trade cheaply because, well, they deserve to.

He refers to this as the “value trap.”

“Today, things look cheap versus a year ago,” Boyd said. “But this doesn’t mean they represent good value.”

Certainly, not all fund managers are pessimistic. Some managers said they thought the market correction is nearing its end.

For instance, Tom Marsico, manager of the Marsico Focus and Marsico Growth & Income funds, said he believes “we’re closer to the end of the correction rather than at the beginning of a major crash.”

And Jim Margard, manager of the Rainier Small/Mid Cap Equity and Core Equity funds, said he believes small and medium-sized stocks are definitely due for a rally. He has increased his funds’ cash stake to take advantage of the situation.

But a surprising number of managers say they simply can’t figure the current market out.

“I haven’t a clue when this will stop,” said Chuck Akre, manager of the FBR Small Cap Value fund. “I haven’t a clue. I have no idea whether I’m going to pull the trigger [and buy into this market] or not tomorrow.”

Eveillard said he feels the same way. But this much he knows: “Experience has almost been a handicap over the past two or three years, in terms of erring on the side of being too cautious.

“But when things get difficult, maybe some of the younger managers who’ve never been in a bear market will understand that experience helps.”