Every mutual fund (MF) scheme is mandated to invest at least 65% of their portfolio in a set of securities that best resembles the objective of the fund. Over and above that, they are free to invest elsewhere or even hold cash. Most equity funds, though, prefer to keep 5-10% in cash.
Redemptions and inflows
Most equity funds retain cash in anticipation of redemptions. If there are panic redemptions, fund managers may have to sell their securities at throwaway prices to meet them. Open-ended funds have an obligation to give money to unitholders whenever they demand. Typically, a cash holding of, say, 5-10% is enough to meet redemptions at all times, but in times like September and October 2008, such limits may not be enough. On account of the global credit crisis back then, investors rushed to withdraw their money from equity as well as debt funds. A number of debt funds and equity funds suffered on account of panic redemptions.
New fund offers
Newly launched schemes or new fund offers (NFOs) may show much larger cash allocation in the initial months. For instance, when Peerless Equity Fund (PEF) was launched in September 2011, it had about 48% in cash at the end of October 2011. By the end of December 2011, it still had about 19% in cash. As per its latest available fact sheet, as on the end of February 2012, it had 11.43% in cash. Newly launched schemes have a window of a month to about three months to invest their proceeds. It may vary from fund house to fund house; the offer document usually mentions this. Typically, the fund manager of a newly launched scheme doesn’t deploy all the NFO proceeds at one go. Till about three years back, well-publicized NFOs used to collect about Rs 500-1,000 crore that had to be deployed over a period of four to six months. Today, very few NFOs attract up to—or maybe a little more than—Rs 100 crore as equity markets are volatile and advertising and marketing budgets across the MF industry have been squeezed. PEF’s collection was about Rs 25 crore. These days it takes a lot less time for the fund manager to deploy his new proceeds.
Mutual funds also hold cash to be able to buy any stock if the fund manager finds new opportunities. Some fund houses, including HDFC Asset Management Co. Ltd, do not believe in holding too much cash. They prefer to stay invested in equities as much as possible because their fund management believes that asset allocation (percentage of portfolio that should be invested in equities and cash) is the investor’s decision and not the fund managers’. However, some fund houses or even dynamic equity funds (those can remain largely in cash during volatile markets) use cash as a strategy to soften the volatility blow. For instance, ICICI Prudential Dynamic Fund can invest up to 35% in cash as a temporary tool to tackle extreme volatility.