What Cash? In an Equity Schemes? Yes, in a pure Equity Scheme. Well, this might surprise some of you but Mutual Funds Have Cash do hold a good amount of cash in its portfolio. Mutual Fund Hold Cash to almost 5-10% in normal times & can go up to 50 to 60% in unfavorable market situations. But Why Mutual Funds Have Cash especially in the equity category?
Arent, it supposed to invest in securities as mentioned in the objective?
Or, is it some illegal activity.
Calm down.. it is legal & Mutual Fund Hold Cash for your benefit in most cases.
I hope you have not invested in Franklin MF six schemes which were compulsory winded up. One of the causes of that event was – Liquidity Levels.
As redemptions were coming down, the fund portfolio did not have adequate cash to pay back to investors who wanted to withdraw. So fund had to sell securities in the market at whatever rate it is getting or had to take a loan to meet its short-term obligations. Both things are not good if it continues for a long time. Hence Franklin Templeton episode happened.
So cash is an important part of the portfolio.
Why Mutual Funds Have Cash?
An MF scheme holds cash for the following reasons:
-
Meeting Redemptions
MF is all about liquidity. Investors come & go as per the requirement. When they come with money it is ok for the fund, but what if investors want the money back?
In that case, one has to sell the securities. But you know when you sell something untimely it may be sold at below expectation levels.
Also, fund managers invest based on a view on the basis of time For eg a fund manager may decide to invest in a bond of 9% with a 6 years view. But here comes the redemption in 2nd year. So fund manager has to sell and forego benefits for the next 4-5 years. May be few other investors invest on next day. But fund management may not get the same bond with the same yield or better yield. hence cash is required to safeguard your long-term securities.
Same way in equity a fund manager may buy HLL looking at a good monsoon season. So he would like to keep the shares for next 4-6 months. But an untimely withdrawal may force it to sell and lose future returns.
2. Investment Opportunities
Gautam Baid in his book The Joys of Compounding says – “Cash is a call option on opportunity.”
Imagine a situation like covid 19 in March-April 2020. Markets crashed roughly 37%. Some shares of good companies came down by 50% or even more.
We all know, we have to invest at bottoms and sell at highs to make money. But what if you do not have cash when markets give you an opportunity.
Hence cash is important to utilize important events that are happening in markets on day to day basis.
Similarly, when markets are peak or valued high, a fund manager may cash down and sell profits and choose to keep cash or distribute in form of dividends. In absence of cash approval, he may not be able to do so.
3. Short Term Parking fo Funds
Mutual Fund Hold Cash to enter particular security at specified rates. There is no point in buying something costly as it limits returns. So one may wait for some time and then buy at satisfying levels.
Warren Buffet in his 2010 letter called “Life & Debt” says –that’s (cash) what allowed us to invest $15.6 billion in 25 days of panic following the Lehman Bankruptcy in 2008.
The Double Edge of Cash Level
As mentioned in point 2 above, cash is used as an asset class to book profits or to invest during the correction phase.
But at times it becomes a double-edged sword if –
- The market does not correct and the fund manager has to keep cash for the long term. The returns will come down.
- A short cash level may decrease return in case the market corrects but the fund manager has no liquidity to deeply in corrected shares.
- Investor tends to lose money if equity is doing better than cash returns and fund has excess cash.
- MF company also loses fees as its fee-charging capacity comes down if a scheme has excess cash levels.
So, we see that inadequate cash levels are not good for anyone.
Cash levels sometimes give a misconception on performance
It is also an important point. Sometimes a scheme may do better just because it was fully invested when markets were in bull phase. Conversely, we may see a period of underperformance when the fund was sitting on cash but markets rose.
Similar things may help the fund to show overperformance or underperformance when markets correct. Naturally a fund with more cash will do better than a fully stuffed fund when markets have declined.
But as the market movement is short-lived, so is the fund’s performance.
One must-see if cash is the reason for temporary performance. It may be wise not to take a decision to invest based on overperformance due to cash reasons.
When High Cash Level in Mutal Fund Scheme is good?
- In a fund with less liquidity like a small-cap fund or value funds.
- When markets are overvalued.
- When withdrawals are expected more than purchases (a bear phase or a phase where withdrawals are looking at higher side due to demand of money (reasons – IPOs, Tax payment deadlines or unexpected phase of regrowth like covid.)
Cash levels will never be good for reverse situations as mentioned above.
Should you worry about cash levels in Mutual Fund Schemes?
Yes, do watch the scheme you have invested in.
If your MF scheme is taking huge cash calls it is not creating value. A cash level of up to 10% is ok. Over than this that too on a frequent basis – it is speculation by the fund management level. It also speaks about their inability to manage asset allocation in the funds.
Mutual Fund Holding Cash is not a sin but one has to justify the levels.
