Cash cushion is a crucial factor in judging the riskiness of an equity fund


May 05, 1991|By WERNER RENBERG

Next to yields and rates of total return, few data on equity mutual funds are studied as much as cash ratios -- that is, the percentage of assets invested in U.S. Treasury bills and other cash equivalents.

You can better judge a fund's performance record and prospects if you know whether its cash ratio is usually high, low or variable -- and why it has been rising or falling, if that's the case.

Cash acts as a drag on fund performance during periods of rising stock prices. It acts as a cushion, however, when stock prices are falling, because cash always earns at least a modest return.

Thus, a fund that maintains a cash position of 15 percent to 20 percent to moderate its volatility and still consistently outperforms its peers is probably being managed by a superior stock picker. You may find it an attractive investment.

A fund that normally has 5 percent or less of its assets in cash is likely to be more risky. If well-managed, it could outperform its peers over the long run and could serve you well. But you'd have to be able to tolerate its volatility.

Funds change their cash levels for a variety of reasons.

Some fund managers practice "market timing." They switch from cash to stocks or vice versa because of changes in the market's direction. While the theory of buying at market bottoms and selling at market tops sounds good, it's difficult, if not impossible, to carry out consistently.

Other strategies call for selling stocks when they reach certain prices. This often occurs when the market is near a cyclical peak. If managers defer replacing these stocks because they believe other stocks are priced too high, cash piles up. Such managers appear to be market timers, although they often insist that they reject this technique.

Cash also can build up when investors shower money on a fund whose performance is getting a lot of publicity and whose portfolio manager can't invest the money fast enough. This is especially true of funds that invest in small companies with few shares outstanding. Their managers don't want to bid for these stocks too aggressively, lest they drive prices up.

Now, with stock averages close to their new highs and investors continuing to add to their fund holdings, you might think that cash levels would be rising. Apparently, they're not. In fact, the Investment Company Institute reported last week that the cash ratios of all equity funds had dropped from 10.6 percent at the end of February to 9.9 percent at the end of March -- the lowest level since July 1989.

From a sampling of about 30 large Fidelity equity funds, for example, only one (not identified) held 20 percent cash -- about 10 were at that level at the end of 1990. Even after the strong first quarter, most are nonetheless around 5 percent.

"We see the economy bottoming," says Alan Leifer, portfolio manager of Fidelity Trend Fund. "Even at these market levels we find adequate investment opportunities to deploy the cash that's coming in."

Foster Friess, whose high-performing Brandywine Fund had been at 55 percent cash at the start of the year, remains in the fully invested position to which he had moved in mid-January. "Highs in the index are completely irrelevant," he says.

A high cash position certainly hasn't hurt the performance of Delaware's DelCap Fund. Even though its manager, Edward N. Antoian, has held about 25 percent cash since the fund's inception in 1986, the fund led all others for the last five years with an average total return of 33.7 percent.

Nor have high cash ratios hurt the performance records of three Janus funds. Thomas Marsico brought down Janus Twenty's cash position this year from 20 percent to 10 percent, despite a flood of new money that has helped fund assets more than double to over $500 million. His colleague, James Craig, has moved less aggressively, reducing the cash in Janus Fund and Janus Venture from 36 percent and 50 percent to no less than 28 percent and 37 per cent, respectively. He still had difficulty finding stocks with desirable risk-reward characteristics, he explained.

Twentieth Century's aggressive growth funds, on the other hand, ranked among the leaders while remaining fully invested. The firm held their cash to 5 per cent or less because of its conviction that short-term market moves can't be predicted consistently. "When the market takes off," says Robert Puff, vice president for equity investments, "our shareholders don't want us to be 50 percent in cash."

Not all agree. Dreyfus' aggressive funds, for example, have been raising cash, one going to 45 percent. Howard Stein, chief executive officer, regards the billions that people have parked in Dreyfus money-market funds as a bearish sign for the economy. He doubts these "new savers" will be tempted to spend for a while even if interest rates are reduced. And he adds: "The recession will be long."

How should cash ratios influence your decision in selecting a fund?

In comparing the data on funds you're considering, focus first on total returns to check which ones have consistently performed well over three or more years. Then examine the cash ratios.

If you spot a fund that has done well through market ups and downs while remaining fully invested, and if you don't mind its volatility, its low cash ratio should not trouble you. But if you are risk-averse, concentrate on finding one that has done well despite a high cash position.

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