Cash as a fund portfolio management tool
Funds have an option to park cash temporarily. Some use it strategically to tide over volatility, investing up to 35% of assets in cash. Yet, some do it regularly. Is that good for your money?
The next time you open your mutual fund’s factsheet (the statement that tells you where all your fund has invested in), notice the last item on the list. It will typically be “cash and cash equivalents”.
As per data provided to us by Morningstar India, a mutual fund tracking and research firm, fund houses have on an average held 92% (at the end of 2011) of their equity assets in their overall portfolios, up to 95.04% by the end of 2014 and 94% at the moment. The rest lies in cash. Why does your fund invest in cash? Is cash an investment at all?
Let’s put it in another way: if you have given your money to a fund manager, can she hold cash? The reality is: yes she can. So what’s the point?
The ups and downs of cash
DSP BlackRock Top100 was a well-performing scheme in its heydays. In 2006, 2007 and 2008, it was in the top quintiles when compared to other large-cap equity schemes.
In 2006 and 2007, it returned 47% and 65%, respectively; in 2008 it lost 46% whereas the category had lost 49%.
On the back of equity markets falling, the scheme hiked its cash level from 3.9% at the end of December 2008, to 7.94% by the end of March 2009.
On 9 March 2009, the S&P BSE Sensex started rising suddenly. From 8,160.4 levels as of that day, it quickly rose to 14,284 on 18 May. The scheme briefly reduced its cash in April and May 2009, but after the central government elections in May 2009, the markets continued to go up.
The fund again hiked its cash in June 2009 to 9.33% and eventually lost traction that year.
By the end of 2009, it had returned 77%; a middle-tier performance for that year.
Take another example. UTI Opportunities Fund had 36% cash by the end of February 2009. By the end of May 2009 it had brought down its cash levels to 10.08% and 9.29% by July 2009.
In 2009, it returned 97.6% and finished in the top quintile.
Two examples of how cash can impact a scheme’s fortune.
Why do fund managers choose cash?
The Rs16-trillion (average assets under management at the end of June-September 2016) Indian mutual funds industry is divided when it comes to using cash as a portfolio management tool. As per regulations laid down by the capital market regulator Securities and Exchange Board of India (Sebi): to be classified as an equity fund, the equity funds has to have least 65% of its assets in equities. Else, the scheme gets classified as a debt fund. If a mutual fund is classified as an equity fund, its investors enjoy long-term capital gains benefits.
In other words, equity funds typically invest up to 35% in cash. Else, the scheme gets classified as a debt fund. And there are some schemes that prefer holding cash.
What is the logic behind this? S. Naren, executive director and chief investment officer, ICICI Prudential Asset Management Co. Ltd, said investors tend to invest when equity markets are at a high and avoid equity markets when they are at a low, when it should be the opposite. Between 1 January and 29 February 2016, the S&P BSE Sensex went down by more than 3,000 points, or 12%. Yet, equity funds recorded an inflow of just Rs56,288 crore as per figures of the Association of Mutual Fund of India (Amfi; the mutual fund industry’s trade body).
Between 31 December 2014 and 3 March 2015, Sensex went up by 7.62% or 2,094 points. Equity funds saw a total inflow of Rs63,365 crore in those four months. “In such cases, it helps if schemes can hold cash, so that investors (by way of their equity funds) don’t end up buying equities at higher levels,” said Naren. One of his fund house’s schemes, ICICI Prudential Dynamic Plan, can hold cash up to 35% of its portfolio during volatile markets.. Naren said it doesn’t make sense to have all funds follow a cash strategy, as it can get “stressful for fund managers if equity markets keep going up consistently despite high valuations.”
Then again, fund house like Quantum Asset Management Co. Ltd, which has a cash philosophy across its fund houses through the two equity schemes it manages: Quantum Long Term Equity Fund and Quantum Tax Savings Fund.
Not all fund managers like having cash in their portfolios. Prashant Jain, executive director and chief investment officer, HDFC Asset Management Co. Ltd said: “Fund managers have a pathetic track record of timing the markets. Sometimes, markets don’t correct even if we feel that they are on a high. They have been known to keep going up for as much as 2-3 years. The fund that takes on too much cash in this period can suffer badly.”
In fact, many advisors believe that fund managers shouldn’t do asset allocation. “Asset allocation is the domain of the investor and the adviser, which is framed after detailed discussion of investor’s goals and risk profile. Once an investor has decided to allocate money to—for example an equity fund—then for the fund manager to hold a large portion of cash, consistently, is not a viable strategy,” said Kunal Valia, director, Credit Suisse Securities India. According to Morningstar data, fund houses like Franklin Templeton Asset Management (India) Pvt Ltd and HDFC have had cash levels of typically below 5%, even in 2008 and 2009.
What to do
According to Morningstar data, the Indian mutual fund industry has schemes that sit on either side of the cash strategy. Schemes like IDFC Dynamic Equity, BOI AXA Mid Cap Equity & Debt fund and Invesco India Dynamic Equity fund have had cash of about 59%, 35% and 21%, respectively, on an average over the past 5-year periods. Schemes like Reliance Tax Saver Fund, HDFC Equity and HDFC Top 200 have held just 1.07%, 1.14% and 1.17% in cash on an average. Further, there are equity funds that follow a dynamic equity investing strategy, that swings between cash and equities regularly. The rewards for you and your fund manager can be high if your fund manager can use cash effectively. But it is a high-stakes game that comes with risk. Unless you are okay with the accompanying volatility, we suggest you do your asset allocation and stick to funds that stick to equity.
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First Published:16 Nov 2016, 08:23 AM IST
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