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Cash holdings of mutual funds matter in the short term

It isn't a very important criterion to look at in the long run, as fund managers make up for the opportunities lost

Neha Pandey Deoras  |  Mumbai 

ICICI Prudential Asset Management Company has increased cash holdings in some of its funds like Dynamic Fund and Balanced Advantage Fund. "In Dynamic, we were holding about 20 per cent in cash as of March-end. In the other, we have used derivatives," said Sankaran Naren, chief investment officer of the company.

Though fund managers advise staying invested irrespective of market conditions, they tend to deviate from this mantra many times. Of course, they are savvier than individual investors but they also time the market - buy when markets fall and sell when they rise.

When markets rise and fund managers fear these will see correction soon, they redeem and sit on cash. They again buy when markets correct. Sitting on cash means investing in the money market/debt funds, not in equities; it's not that such funds sit on zero earnings. Hemant Rustagi of Wiseinvest Advisors says, "Any mutual fund scheme, debt or equity, also increases cash holding for dealing with redemption pressure." For instance, since 2012, mutual fund schemes have been net buyers only in two months, he adds. The redemption pressure has been high.

On the other hand, a well-known fund manager says he believes in staying invested all the time. Most of his funds are fully invested, irrespective of market levels. He is more concerned about prevailing liquidity requirement and portfolio changes than short-term market outlook.

"Assume my fund's compounded annual growth rate (CAGR) stands at 20 per cent a year through the last 20 years. If the fund sits on, say, five per cent cash, its returns will be 19 per cent CAGR. For a salaried individual, that one per cent difference in returns translates into a lot of money," the fund manager argues. "While the Sensex moved from 100 to 20,000 in 35 years, most of my funds' net asset value (NAV) has moved from Rs 10 to Rs 350 in 20 years; that is, they gave 30-35 per cent returns. In that case, how does it matter whether the funds lost 10-15 per cent due to market corrections by being fully invested?"

Needless to say, these calls might not always work. Naren says the advantage of increasing cash holding in rising markets is that a fund's beta (a measure of volatility) falls on moving to cash when markets are high, lowering risks. In 2008 and 2011, this strategy helped many funds perform well. On the flip side, this strategy led to losing opportunities during the 2007 and 2009 market rallies. High beta leads to fast stock run-ups in good market conditions and heavy losses in a bad market.

Naren feels this strategy might be true for some funds but isn't a general rule during market upswings.

According to data from MF rating agency Value Research, of the 370 equity schemes available, 78 have increased their cash holding between December 31, 2013, and March 31 this year. Large-cap UTI Top 100 Fund has increased its cash holding to 3.32 per cent of the assets under management, from 0.95 per cent. Equity-diversified Franklin India Prima Plus Fund has increased it from 2.08 per cent to 5.48 per cent. Another equity-diversified fund, Birla Sun Life Long Term Advantage, increased its cash position from 1.72 per cent to 2.13 per cent.

Experts say funds sat on cash in the initial days of the current market rally, which began on February 13. Monthly data show Tata Ethical Plan increased its cash holding from 7.71 per cent on January 31 to 8.56 per cent on March 31. UTI Pharma and Healthcare increased it from eight per cent to 11.5 per cent.

Vidya Bala, Head of MF research, FundsIndia.com, says that there were more funds with higher cash holding in September 2013. With the rally that ensued, many quickly increased their exposure to equities and had lowered cash positions by December. Dynamic funds (ICICI Pru Dynamic) or funds with a deep value focus (PPFAS Long Term Value) or conservative ones with an eye on valuation (Quantum Long Term Equity), besides others (IDFC Sterling Equity) which might still be waiting for the right midcap opportunities, were the ones with less than 90 per cent equity holding as of March 2014."

In comparison to cash holdings as on March 31, 2014, funds were sitting on higher cash levels in May 2009. For instance, LIC Nomura MF Equity Fund sat on 30-38 per cent cash between December 2008 and May 2009.

As far as investors are concerned, the cash holding in a fund could play a major role in determining its performance. To be under-invested at the beginning of a rally could lead to underperformance. Similarly, being over-exposed could hurt the fund if the market is about to fall. "Whenever there is a market upswing, it is better if funds are already invested into stocks, as this enables them to capture the rally. On the other hand, equity funds which hold too much cash will underperform during an upswing," says Renu Pothen, research head, iFast Financial India. Unless specifically stated in its mandate, an equity fund's primary job is to find opportunities in the market at all times.

Agrees Bala and adds, "While some funds miss the bus, a few others are adept at joining an upswing without wasting much time. Axis Equity held 87 per cent in equities in September 2013 but quickly moved to 93 per cent in December and 97 per cent in March 2014. It still missed out a bit on returns."

Therefore, experts feels investors should track the cash holdings of their funds. "Usually, we recommend investors to invest their surplus into funds that are fully invested into equities during all market cycles," Pothen says.

Rustagi, however, feels once you've handed your money to a fund manager, you shouldn't bother with these factors. This is because your views need not match with that of the fund manager's. Usually, you won't understand the investment strategy behind repositioning cash levels. "Even if a fund stays invested when there is redemption pressure, liquid stocks are sold first as they are easy to sell and illiquid ones are held on to. This makes the fund volatile in the short term. But mostly, fund managers make up for these in the long run," he says. Just ensure you invest in a well-diversified fund, one that has given better returns than its peers consistently.

First Published: Sun, April 27 2014. 22:27 IST
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