The cash level of the overall equity mutual fund industry was 5.4 percent in July (up from 4.6 percent in June). Analysing the cash or cash equivalent of a mutual fund is one more tool which can help better understand the way a fund manager is managing the fund, and enable us to make an informed investment decision.
The cash level of a mutual fund is the percentage of a mutual fund’s total assets that’s held in cash or cash equivalents. The purpose of holding cash is to have liquidity to support redemptions, or buy stocks later if the fund manager anticipates current market valuations to be high and expects them to go down.
Cash levels
The typical cash level of an equity mutual fund is about 5 percent. However, various funds maintain lower (or higher) levels of cash. Overall, the cash level of the equity mutual fund industry was 5.4 percent in July 2024 (up from 4.6 percent in June 2024). The rise in the cash level was on account of concerns about elevated valuations as well as attractive new fund offers (where money was yet to be deployed).
At an individual fund house level, the variations may be more pronounced. As per a Motilal Oswal report for July 2024, Parag Parikh Financial Advisory Services (PPFAS MF) had the highest cash holding at 16.1 percent. Quant Mutual Fund sharply increased its cash holding to 14 percent in July (compared to 7.2 percent in June 2024).
What works and what doesn’t
A fund manager can use the cash strategically and tactically. She could temporarily increase cash levels during times of high volatility to cushion falls or time her entry into stocks. This is the classic strategy to buy the dip.
But this can backfire. Cash typically has lower yield than equity (in a steady state). So, elevated levels of cash could dampen the overall returns of a fund if the call does not go right.
Cash as a tool for fund managers
Fund managers have different approaches to cash levels.
Some believe that the investor (or his advisor) has done the asset allocation and given her the funds to manage as per the fund’s mandate, hence having a large quantum of cash is akin to duplicating the investor’s cash holding. So, they have a stated policy to keep cash level at minimum levels (needed for liquidity to support redemptions, etc.)
Some fund managers believe in using cash tactically. You would see shifts in cash levels (going up or down) with changing market cycles and trends.
Others may increase their cash holdings if they are not able to find sufficient investment ideas per the mandate (could be due to elevated valuations) for the quantum of flows coming into the fund. One would notice cash levels going up before the fund manager starts limiting inflows (e.g., no lump sum, only SIPs, etc.)
Implications for investors
A cash level of 1-5 percent in an equity mutual fund is normal. An elevated cash level of 5-10 percent indicates that the fund manager may be tactically using elevated cash levels for buying on dips, or is managing the deployment of recent high inflows in a staggered manner. However, if the level of cash is in this range for a longish period, then one would need to study if the higher level of cash is impacting returns.
A significantly elevated cash level of 10+ percent indicates the fund manager is worried about valuations and may be expecting a correction. An investor should also assess if this is the right time to add to the fund (especially lump sum investments).
Should a fund’s cash level influence your decision?
Analysing the cash or cash equivalent of a mutual fund is one more tool which can be used to better understand the way a fund manager is managing the fund.
While this cannot be the sole reason for investing, or not, in a fund (your underlying goals, time horizon, and risk appetite are far more important factors), it does provide a very valuable pointer on the mindset of the fund manager, and can be a very useful input for making an informed decision.
