Another reason, according to experts, is that political uncertainty is affecting sentiment. “Several state elections are due this year, and then we have the general elections next year. Many fund managers are sitting on cash because of the current volatility in the markets, and to see how things shape up politically,” says Vivek Agarwal, co-founder, Upwardly.in, an online advisory and investment platform. Some funds, such as value funds and dynamic asset allocation funds, allocate to equities based on market valuations. When valuations move high, they move into cash.
Steady inflows, but few opportunities:
Many fund managers are also facing the problem of plenty. While the industry is receiving monthly inflows of Rs 75 billion through systematic investment plans, there aren’t many opportunities due to the high valuations in the midcap and smallcap segments. Even many large-cap stocks seem overvalued.
There are risks too: During the financial crisis of 2008, many fund managers had gone heavily into cash to prevent their funds from correcting deeply. However, when the markets rebounded in 2009, these funds were left on the sidelines. Their performance took a knock, and it took them several quarters to catch up with peers who were fully invested. After this, many fund houses introduced internal rules stipulating that fund managers should not take more than five per cent exposure to cash. According to Radhika Gupta, CEO, Edelweiss Asset Management: “As a fund house, we don’t like to take cash calls of more than 4-5 per cent in long-only equity funds. When fund managers take high cash allocation calls, it implies that they are trying to time the market, a tricky thing for any fund manager to pull off consistently.”
When funds take large cash calls, it also skews the investor’s asset allocation. A simple example will help illustrate this point. Suppose that an investor wants 50 per cent equity and 50 per cent fixed income exposure in his portfolio. He invests the 50 per cent in an equity fund. But the fund manager invests only 70 per cent of his fund portfolio in equities. As a result, the investor’s equity allocation falls to 35 per cent. This is a more conservative allocation than he desires and could affect his long-term returns. Asset allocation, says Gupta, is best left to advisors and investors themselves.
Exceptions to this rule: While most equity funds should stay almost fully invested, dynamic asset allocation funds and value funds are exceptions. Dynamic asset allocation funds, as their name implies, take asset allocation calls, often based on a formula. When markets become expensive, as indicated by price to earnings (P/E) or price to book value (P/BV) ratio, they reduce allocation to equities, and vice-versa.
Value-oriented funds are the other exception. Quantum Long Term Equity Value Fund, for instance, doesn’t shy of parking a considerable portion of its portfolio in cash if the situation warrants. Says Atul Kumar, head-equity funds, Quantum Asset Management: “If we find value in stocks, we stay invested. But many of the stocks that we held reached the sell limit we had set for them, so we were forced to sell them. We are also finding fewer new opportunities. That is why our cash level has gone up. It is not a tactical call. It comes out of our bottom-up, process-driven approach.”
PPFAS Long Term Equity Fund currently has a cash allocation of 23.28 per cent. Explaining the fund’s approach, Rajeev Thakkar, chief investment officer and director, PPFAS Mutual Fund says: “We don’t start off with any target cash position. Our objective is to deploy everything in equities. But if we find stocks worth investing in only up to 77 per cent of our corpus, then 23 per cent will be the residual cash that will lie around till we find suitable opportunities.”
Going into cash can prove advantageous in certain situations. Says Thakkar: “If there is a significant correction, the cash position could become a significant factor responsible for outperformance.” He adds that being in cash also gives the fund manager opportunities to buy stocks at attractive valuations when the markets or select stocks correct.
Should you worry about high cash levels? Be aware of the mandate of your fund. If it says that the fund will not take high cash calls, and yet the fund manager maintains a cash level of above 10 per cent for more than a quarter, you should be worried. Speak to your financial advisor about whether the fund manager is flouting his mandate and if you should exit. On the other hand, if you have invested in a tried and tested asset allocation fund or a value-oriented fund, which has proved its mettle across market cycles, then you should not worry even if your fund goes into cash in a big way.