Cash Hoarders May Get Chance at Redemption

What funds’ cash levels have to say about the future of the market

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Stock funds' cash positions, measured as a percentage of total assets, have taken a nearly historic plunge, according to data from the Investment Company Institute, or ICI. Specifically, stock funds had 3.6 percent of their portfolios in cash at the end of January 2010, down from 5.7 percent at the end of January 2009. 

[See U.S. News's list of the Best Mutual Funds for 2010.] 

News of the drop immediately touched off speculation about whether the market's yearlong rally is running out of steam now that managers are seemingly running out of cash to spend on new stock purchases. 

If this slowdown materializes, it could produce some unlikely heroes. Notably, managers who have maintained large cash stakes even as stocks exploded in value have come under scrutiny for missing out on the bull market, but if there's a turnaround, they may emerge as the only ones who have enough liquidity to truly capitalize on attractive valuations. "If the market turns in their direction and they're able to pick up securities with bright futures at a time when everybody else has already loaded up on the best performers to date, then that could be a great position to be in," says Jeff Tjornehoj, Lipper's research manager for the United States and Canada. 

Already, some of the fund industry's more opportunistic players are starting to salivate. The Encompass Fund, for instance, currently has upwards of 20 percent of its portfolio in cash, and comanager Malcolm Gissen sees this large stake as a chance to scoop up bargains at a time when his competitors aren't in a position to buy new securities without first unloading some of what they currently own. "We think it's a terrific advantage because we continue to see some very exciting opportunities," Gissen says. "Having the cash enables us to select which of these opportunities we will invest in." 

[For Money Market Funds, Changes Are Mostly Cosmetic.] 

Still, the value of these opportunities should be taken with a grain of salt. For starters, even if funds with large cash positions find themselves temporarily in the limelight, it will be a trade-off at best. That's because the same conditions that could allow them to thrive in the near future put them at a disadvantage in 2009, when large cash stakes tended to be a drag on performance. To be sure, though, not all cash-heavy funds lagged during the rally. Gissen's fund, for example, returned 140 percent last year, even with significant chunks of its portfolio in cash. 

The more important caveat, however, is that it's not clear whether managers have actually cut back all that much on their cash reserves over the past year. Those who claim that the ICI data suggest that managers are "burning through cash" are correct to point out that funds' cash levels have fallen at the fastest clip the market has seen since 1991, but they are very likely missing the point. As well-known trader Don Fishback points out in a recent blog post, the dollar value of funds' cash positions has remained relatively stable over the past several months, moving from $177 billion at the end of February 2009 to $172 billion at the close of January 2010. 

What's changed, then, is not so much cash levels as the value of stocks. As stock prices shot up, so did the overall value of portfolios. On the other hand, returns on cash have been so small that they can virtually be written off entirely. That means that even though cash positions, at least in absolute terms, stayed more or less fixed, they began to represent an increasingly lower percentage of overall assets under management.