Top fund managers O. Mason Hawkins and G. Staley Cates say a rise in merger & acquisition activity has made it harder to find attractive value stocks. But they remain optimistic on equities for the long term.

In their Longleaf Partners quarterly letter, Hawkins and Cates say the long-running bull market, low volatility, heightened activism, and investor complacency have all contributed to the lack of opportunities. “The largest driver of what we see as market overvaluation has been the rise in merger and acquisition activity encouraged by the Federal Reserve’s (Fed) commitment to historically low interest rates combined with the strength of corporate balance sheets, plus the aforementioned inversion [US firms buying foreign businesses and then redomiciling overseas] driven by the world’s highest corporate tax rate,” they write. “Transaction activity has been a double-edged sword. Our performance has benefitted, but new investment opportunities have almost disappeared as stocks have moved from earnings-based multiples toward deal multiples.”

The duo says cash levels in their two domestic funds are 26% and 47%. But, they add, “Cash levels are a residual outcome of our process rather than a reflection of a bearish market view. With our ongoing analytical work, we are building a robust on-deck list to be prepared to act whenever prices cooperate. A market correction could provide an expedient way to find adequately discounted businesses but is not necessary for us to put cash to work. Increased volatility, individual company idiosyncrasies, and value growth ahead of price gains also could generate qualifying opportunities such as they have outside of the U.S. this year.” They also say that “equities remain attractive versus bonds and most other asset classes”.