Fund manager isn't there to sit on cash

Your Funds

Dollars & Sense

August 25, 2002|By CHARLES JAFFE

IN THE LATE 1990s, when stocks were booming, investors were unhappy with any mutual fund that kept a big slug of assets in cash.

Today, when a chunk of change helps to shrink losses, no one seems to mind if there's cash in a fund's portfolio.

But fund specialists say that investors might actually want to be upset even if a fund manager's decision to hold cash results in better profits or reduced losses. Why? Holding excessive cash may mean that a manager has strayed from his or her mission.

"When a manager uses cash as a hiding place, that's inappropriate," says Roy Weitz, who runs the Web site, which specializes in telling investors when to sell funds. "But it's hard to distinguish between the managers who are opportunistic and use cash for strategic reasons and the managers who are just scared and trying anything to make their performance look better right now."

The average domestic stock fund holds about 5.2 percent of its assets in cash, according to Morningstar Inc., down slightly during the past six years. But cash holdings at some prominent companies appear to be on the rise; at Fidelity Investments, the average stock fund had more than 6 percent of its assets in cash June 30. While that's down from more than 8 percent in March, it's way above the company's cash levels during the 1990s.

Any stock fund with more than 5 percent of assets in cash has bottled up a lot of its investing power.

Stock funds invest cash in money-market securities, so that their cash generates the kind of return an investor might find in a money-market fund.

But because stock funds charge much more in expenses than money funds, the bulk of the cash's return gets eaten by costs.

"Having your funds hold cash is an expensive way to get money-market returns," says Russel Kinnel, director of fund analysis at Morningstar. "That's not why you invested in a stock fund."

Fund managers have two basic reasons for holding more cash; either they can't find anything worth buying within their investment style or they feel the need to prepare for possible redemptions.

Statistics showing that money is flowing out of stock funds and into bonds, bond funds and cash would indicate that there might be a need to boost cash reserves. But the "increased redemption reserves" excuse shouldn't apply to funds that hold large, liquid stocks or that have regular in-flows from retirement-savings plans.

Further, managers who claim they "can't find anything to buy" are taking a position that is difficult to justify. If there was plenty of selection when the markets were buoyant and prices were high, logic dictates that there are more bargains available now.

Positioning the fund so it will be ready for future opportunities makes sense provided the manager has made similar moves before, regardless of market conditions.

"If you see cash rise and the manager has a history of letting this happen based on market conditions, that's one thing," says A. Michael Lipper, a long-time fund observer who runs Lipper Advisory Services, a Summit, N.J., hedge-fund firm.

"The real problem for some managers is that cash becomes too comfortable, so that every upward move is just a rally in a bear market rather than the beginnings of a new recovery or a bull market. Managers who feel that way miss out on the turnaround ... and the stock fund managers who have used their cash really well strategically have been few and far between."

When a fund increases its cash holdings, it affects the shareholder's total asset allocation.

Say an investor has built a balanced portfolio, with half of the money in stock funds and the other half split between bonds and cash. If the stock funds hold above-average cash positions, it skews that investor's portfolio balance.

"As a general rule, funds should be fully invested," says Geoff Bobroff of Bobroff Consulting Group in East Greenwich, R.I. "People are paying for the manager to invest the money, not sit on it.

"There's not much of a penalty for holding cash today, the way there was when the market was going strong. But that penalty will return, and it's what investors should worry about."

Investors can determine how much cash a fund is holding by asking the fund firm for current allocations or by examining data reports available at Web sites such as

Cash weighting above the industry average should be factored into allocation decisions. Any drastic changes in cash holdings - where the cash percentage doubles and exceeds industry norms - needs to be watched more carefully.

Says Weitz: "Regardless of market conditions, something is going on when a fund manager doubles his cash stake. You, as a fund investor, are going to want to know what it is."

Charles Jaffe is mutual funds columnist at The Boston Globe. He can be reached by e-mail at or at The Boston Globe, Box 2378, Boston, Mass. 02107-2378.

Baltimore Sun Articles
Please note the green-lined linked article text has been applied commercially without any involvement from our newsroom editors, reporters or any other editorial staff.