Why your equity mutual funds hold cash

Posted on by KNBT

Cash levels in a equity mutual fund goes up if the fund manager believes markets are overvalued and prefers not to invest.

Cash levels in a equity mutual fund goes up if the fund manager believes markets are overvalued and prefers not to invest.

IDBI Banking & Financial Services Fund holds around 78.38% of cash as per its July-end portfolio. How much cash do you expect your equity funds to hold on an average?

If you invest in MFs, you would have noticed cash positions of, typically, up to 10% in equity funds. But that may not always be the case. Reliance Japan Equity Fund had around 72.03% in cash, as per Value Research. ICICI Prudential Pharma Healthcare and Diagnostics (P.H.D.) Fund has held around 44.03% of cash. Is a high cash allocation normal?

Strategy

Fund managers, typically, hold cash for two reasons. One is to scout for buying opportunities. If a stock’s price falls on a given day or has been falling over a period of time to a level which the fund manager feels is an optimum price to buy, she may buy some shares if she is bullish about the stock and wants more of it. Two, when your fund manager books profits but doesn’t feel the need to redeploy the money soon. She sits on cash till she finds opportunities to buy.

Also read: Top mutual fund schemes

Quantum Asset Management Co. Ltd follows this strategy and hence its cash positions are usually high among diversified funds. As per Value Research, Quantum Long Term Equity Value Fund held close to 20% of its portfolio in cash, as on July-end.

In volatile markets or when markets are consistently rising, some schemes prefer to book profits and hold cash, especially those that continue to get inflows. The cash levels in such funds increases if the fund manager believes markets are overvalued and prefers not to invest.

New funds

Unusually high cash levels are also seen in newly-launched schemes because it takes them time to deploy all the money at one go. That’s why IDBI Banking & Financial Services holds a high amount of cash. The scheme was launched in May. However, Reliance Japan Equity was launched in August 2014 and yet holds an unusually high amount of cash. The fund house said cash levels were high for “operational reasons and they are now down to normal levels”.

What should you do

Many financial planners believe that choosing between making an investment and sitting on cash is like doing asset allocation; a decision best left to the investor and her adviser. Typically, it makes sense to invest with funds that prefer to be fully invested. If equity funds charge an expense ratio, it implies they do so because they manage your money. But if they sit on cash, then what’s the point?

A contrarian view is that equity markets can sometimes bely fundamentals and run away based on momentum. In which case, they say it’s okay for a fund manager to use discretion and sit on cash on a temporary basis, especially if the scheme information document allows it do so. But be prepared for the fund’s cash calls going wrong. It’s a double edged sword.

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