MARLA'S MUSINGS

. . . from the Publisher of Brill's Mutual Funds Interactive^®

When Cash Isn't King

by Marla Brill
Publisher, Brill’s Mutual Funds Interactive

While most people shopping for a stock mutual fund look at things like performance or risk, far fewer find out how much a fund has parked in cash equivalents such as certificates of deposit, commercial paper, or Treasury securities. Yet unless you know the reasons behind an unusually large cash stash, you could be walking into a booby trap with blindfolds on.

To understand why, it helps to go back a decade or so, when many fund managers viewed their role as two-fold: picking the right stocks, and deciding when to be in or out of the stock market. When their view turned bearish, they would sell stocks and put more money into cash. In bullish times, they would keep most of their fund assets in stocks.

These days, the majority of equity fund managers remain fully invested in the stock market. "Typically, a fund retains some cash on hand to meet redemptions," says Ramy Shaalan, mutual fund analyst at Wiesenberger, Thompson Financial. "But it’s usually no more than 10 percent of total assets."

Managers today generally believe their job is to pick the right securities, not decide when to be in or out of the market. The change in thinking occurred, in part, because some managers got caught sitting on the sidelines with too much cash in their coffers during bull markets. With so much money out of play, fund performance lagged. Such a fate befell the Warburg Pincus Growth & Income Fund, a few years ago.

The fund showed its best colors between 1992 and 1994, when manager Anthony Orphanos’s defensive investment maneuvers, which included moving large amounts of money into cash equivalents, served him well in an uncertain stock market. But the strategy backfired in 1995 and 1996 as the bull charged ahead, and the fund got left behind. Not surprisingly, the fund’s next manager, Brian Posner, pledged to keep the fund fully invested.

More recently, Foster Friess of Brandywine fund kept a big cash pile in 1997 and 1998, a move that led to significant under-performance against his mid-cap growth peers in those years. His decision to put the piggybank back to work last year, though somewhat belated, breathed new life into the fund.

Another reason most stock funds don’t move aggressively into cash is the increasing use of asset allocation, particularly among financial advisors. Having a fund that doesn’t "stick to its knitting" by wandering into money market securities can create havoc in the kind of neatly-arranged asset allocation plan professionals favor.

Still, while fully invested is the mantra for most stock funds, a significant number have 20 percent or more of their assets in cash equivalents. The accompanying chart, compiled for Brill’s Mutual Funds Interactive by Wiesenberger, Thomson Financial, indicates that there were 218 of them at the end of 1999.

It’s not necessarily a bad thing if a fund has lots of cash from time to time. What’s important to recognize is why the fund has positioned itself that way. It is often for one of these reasons:

 - A new offering. Funds just starting out may be cash rich for a short time before the manager lines up his investment ducks.

 - Lots of buzz. Funds often experience a huge influx of cash when they’ve become extremely popular, usually because of strong performance and accompanying publicity. If the cash allocation stays over 10 percent or so for several months, it may mean that the manager is having a hard time figuring out what to do with the flood of new money. This is particularly true for a fund that invests in stocks of smaller companies, where liquidity issues often arise as a fund gets bigger.

 - A fund’s stocks have soared. Cash positions often increase when portfolio managers take profits, particularly toward the end of the year. Unless there is a dearth of new ideas, the money should be put back to work fairly quickly.

 - The manager is playing defense. Despite the industry’s fully invested mantra, some stock fund managers still believe they should decide when to be in or out of the stocks market, using cash as a defensive maneuver. In a bull market, shareholders in such funds can find themselves treading water if the call isn’t right.

Click here for funds with lots of cash.