Fund managers are hoarding cash. Are they bracing for a market correction?
Summary
- Mutual fund managers are stockpiling cash, signalling potential concerns about market valuations. As inflows surge, their reluctance to fully deploy capital raises a critical question: are they bracing for a stock market correction, or is this tactical patience?
As India's equity markets soar, mutual fund managers are becoming increasingly cautious. Despite a surge in investor inflows, they are opting to hold on to cash, waiting for more opportune moments to invest amid market volatility and overvalued assets.
This cautious approach, however, comes at a cost to investors, who miss out on potential returns as the cash lies idle while they continue to pay fees on the full investment.
As of August, India's top 20 equity mutual funds, managing ₹4.08 trillion in assets, held an average of 6% in cash—up from 4.4% in January. Quant Mutual Fund led with a 19.1% cash holding, followed by PPFAS at 17.6% and Motilal Oswal at 13.5%, according to a report by Motilal Oswal Financial Services.
This marks the highest cash level since May 2021, when cash holdings had bottomed out at 3.2%, Motilal Oswal Financial told Mint.
While this elevated position is significantly higher than historical averages, it’s not entirely unprecedented. Some portfolio managers have taken cash positions as high as 50-70%, according to industry experts.
In past downturns, such as during the dot-com bubble and the 2013-2014 quantitative easing period, mutual funds held similar or larger cash reserves, pointed out Yash Poddar, co-principal and chief investment strategist at family office Viansh Ventures.
What’s different this time is the rapid acceleration of investment inflows, raising questions about when and where this capital will ultimately be deployed.
Where is the capital going?
Equity mutual funds have been witnessing a steady rise in inflows, with August bringing in ₹38,239.16 crore, a 3% increase over July’s ₹37,113.39 crore.
Between April and June, equity mutual funds brought in ₹94,222.27 crore—far surpassing the ₹18,358.08 crore seen during the same period in 2023.
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Despite this influx, fund managers remain hesitant to deploy most of the capital into assets that could be potentially overvalued. According to market experts, holding cash allows them to pause and re-evaluate strategies before making significant investments.
Much of this caution stems from capital deployment challenges. As inflows surge, fund managers must balance deploying capital quickly and holding cash in anticipation of a market correction. This challenge often arises when there are limited attractive investment options due to inflated market prices.
Indian stock markets have surged significantly, with the benchmark Nifty50 index rising from 19,664.70 points on 1 January to 26,175.15 points as of Friday's closing.
"It's often a tactical decision by fund managers to keep cash on hand, ready to invest when the right opportunity arises," said Anuragg Jhanwar, partner and co-founder, Upwisery Private Wealth, a firm specializing in investment banking and financial advisory services.
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However, there are downsides. Investors still pay the expense ratio on the entire investment, even if a significant portion of it sits idle. If a fund holds 20% in cash, returns are generated only on the balance 80%, so investors lose out on potential gains while still paying fees on the full amount, said Jhanwar.
Currently, the top 20 mutual funds hold $14 billion, or around ₹1.3 trillion, in cash, according to Saurabh Rungta, managing director and chief investment officer at Avendus Wealth Management.
“The industry is receiving nearly $3 billion every month as cash gross SIP inflows, which it continues to deploy. So I wouldn't be surprised if the cash holding percentage of MFs further increases," he said.
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Rungta, who anticipates a 10-15% correction in Indian equities, emphasized that the uncertainty isn’t whether a correction will happen, but when.
Balancing flexibility and underperformance
Holding large cash reserves also exposes fund managers to risks. While it provides flexibility to seize opportunities, it can lead to underperformance if the market continues to rise.
Jhanwar cautioned that asset management companies holding substantial cash risk underperformance in a rising market, depending on how aggressively they manage their cash allocations.
“Our funds are primarily fully invested, with some cash held strategically to allow us to take advantage of market opportunities such as QIPs (qualified institutional placements), IPOs (initial public offerings), and other emerging prospects," Niket Shah, chief investment officer at Motilal Oswal Asset Management Co. said in response to Mint's query. “We manage focused, high-conviction portfolios, where maintaining a neutral position often requires a small cash allocation, typically in the range of 3-4%. This allows us the flexibility to build or exit positions efficiently."
He added that recent new fund offers, profit-taking, and the rebalancing of India's weight in the MSCI Index have temporarily elevated cash levels, while high valuations in many sectors have kept the firm cautious.
Neil Parag Parikh, chairman and chief executive officer, PPFAS MF, told Mint that starting valuations are critical to future returns. With current valuations not appearing cheap, PPFAS is taking time to hunt for bargains, waiting patiently for opportunities where valuations align with their comfort zone, Parikh said.
Quant MF did not respond to queries from Mint.
According to Rungta, mutual funds’ cash holdings are higher than historical averages, signalling caution as fund managers sense the market may have outpaced fundamentals. He pointed out that it has been over 50 months since the Nifty 50 experienced a monthly decline of more than 5%, a telling indicator.
Akhil Chaturvedi, chief business officer, Motilal Oswal Asset Management Co., explained that much of the elevated cash levels stem from fund managers reallocating capital across sectors and a surge in new fund offers, with ₹35,000-40,000 crore launched in the last quarter.
“Cash holdings of 6-7% are fairly typical; nothing to be alarmed about," Chaturvedi said, though he acknowledged that a market decline of 5-15% remains a possibility.
Rungta views a market correction as a natural adjustment unless triggered by an unforeseen event.
Should you pause SIPs then?
The surge in periodic systematic investment plan (SIP) contributions has added another layer of complexity. In August 2024, SIP inflows hit an all-time high of ₹23,547.34 crore, surpassing July’s ₹23,331.75 crore.
But some investors may wonder whether to pause their SIP investments.
According to Rungta, pausing SIPs may make sense for those with a short-term horizon of one to two years, who might prefer shifting to debt. However, for investors with a longer-term outlook (three to five years), continuing SIPs is still advisable.
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Even if fund managers anticipate a correction, SIPs are structured to take advantage of market volatility through rupee cost averaging. So, stopping SIPs could result in missing out on potential gains during upswings, explained Viansh Ventures' Poddar.
"The best approach is to continue SIPs but extend the investment horizon," he said.