A study of 192 diversified equity funds as of February 2009, which includes large- and mid/small-cap funds revealed that these funds switched to cash and cash equivalents to avoid market downturn. The average cash allocation of these 192 funds was 17%, with the top fund having 62% in cash.
We think that the conservative investment approach during the market downturn led these stock fund managers to resort to cash. However, having a cash stake didn’t guarantee that a fund would post a milder loss.
For example: Escorts Growth Plan with 62% of its assets in cash, registered -57% return during the one-year period ended February 2009. Conversely, funds with relatively lesser exposure to cash outperformed.
For example, UTI MNC with 9.7% in cash was the top performer with -32% return. In comparison, diversified equity funds registered -50.9% average returns with average cash exposure of 17%.
It is still noteworthy how many of the better performers had a cash cushion. The cash exposure of top 10-best performing diversified equity funds was in the range of 5%-34%. Most of these stock fund managers are required by their firm to be fully invested, or at least close to it, at all times. So, the question to ask: Should funds be allowed to invest in cash?
Most investors in these funds want fund managers to stay fully invested as they have made a choice to own a particular type of fund and can decide for themselves whether to stash a separate amount of money in cash-like alternative such as liquid fund.
Financial advisors, in particular, take the view that asset allocation is their role, and fund managers should not complicate that effort by holding cash of their own.
When markets are rising, every fund manager wants his fund to be fully invested. There would be few investors who does not understand manager's ideas of holding cash during market rallies and are willing to live with underperformance.
They expect they would be better off when times get tough, and that over the long term the manager's cautious streak will pay off. There were also instances when fund managers were sitting on cash with a view that markets are fairly valued, however, continuous rally in the market resulted in these managers deploying cash at higher levels.
For example, JM Mutual Fund's equity schemes had between 10%-50% of assets in cash as of November 2007, while the same percentages declined to just 2-5% in January 2008 when equities started their declining phase. These funds featured towards the bottom of the list with negative return between 70%-80% for one-year period ended February 2009.
When stocks are falling, some investors might ask: Why didn't you protect me, then? The honest answer might be, You didn't want me to. But would it be preferable to allow managers more discretion?
First, can we count on all managers to use such freedom wisely? Some would be tempted merely to market-time, with unpleasant results. Also, most advisors likely would object to granting wide latitude to fund managers. It's true, as they argue, that dedicated and responsible advisors know their clients' circumstances, preferences, and overall portfolios much better than a distant fund manager could.
I think that conservative approach is good; however, investing equity funds’ money in bank term deposits and keeping higher exposures in cash is certainly not a good idea. If fund manager thinks that there are not good opportunities available or overall equities are likely to underperform further, shareholder needs to be communicated and advised properly, leaving the discretion to shareholder whether to redeem/switch his or her investment or he can be okay with few months of underperformance, which can bring some pleasant surprises on the way.
The role of financial advisors also becomes critical here and they are required to go back to shareholders to check whether there is a need for a change in asset allocation.
