Demystifying Mutual Fund Cash Levels: Everything You Need to Know

Summary

Mutual funds (MFs) offer diversified portfolios, with equity MFs focusing on stocks and bonds, while debt MFs prioritise fixed-income instruments. Cash levels in MFs are crucial, serving liquidity needs and seizing opportunities. Analysis of these cash levels reveals market sentiment and enables strategic decision-making. Equity MFs hold 1-5% cash, suitable for long-term investments, while debt MFs allocate more due to shorter horizons. Cash management in MFs is of critical importance, depending on the fund's objectives and market conditions, guided by fund managers' expertise.

An MF is a collective pool of assets that invests in a variety of securities, including stocks and bonds. Purchasing an MF provides you with a diversified and professionally managed investment portfolio, offering more varied holdings than individual securities. The two most common types of MFs are equity MFs and debt MFs. Equity MFs primarily invest in stocks, bonds, and various securities, and they are the most prevalent MF type in India. On the other hand, debt MFs focus mainly on debt securities like government and corporate bonds, offering fixed returns on investments while deducting expenses from the overall generated returns. 

Mutual funds and their cash levels: A beginner’s guide

MF schemes have specific guidelines regarding the types of securities they can invest in. They are permitted to allocate a small portion of their portfolio to cash. These cash levels are a vital component of an MF's operational strategy. Why? They serve the purpose of meeting redemption requests and seizing potential buying opportunities that may arise on any given day. Typically, MFs maintain around 5% of their portfolio in cash and similar assets to facilitate various transactions and meet redemption requests from investors.

The cash level of an MF represents the proportion of the fund's overall assets invested in cash or cash equivalents such as bank deposits and easily marketable securities, including commercial paper (a common type of unsecured, short-term debt issued by companies) and short-term government bonds. This measure plays a crucial role in effectively managing the fund's liquidity.  Funds often employ derivatives (a financial contract whose worth is contingent upon an underlying asset) to benefit from borrowing money for investing, quick responsiveness, protecting against risks, and keeping expenses low. This may necessitate:

1. Setting aside collateral or valuable items that are pledged to secure a loan, thereby reducing the risk for lenders
2. Maintaining elevated cash reserves for various types of transactions, which tend to hold larger cash balances

Analysing cash levels in mutual funds: Key considerations and their implications

Understanding and evaluating the cash positions within MFs is very critical. It highlights the important factors that investors should think about when evaluating these cash levels and how they might affect their investment plans. Whether you're a seasoned investor or just beginning your journey, grasping these key insights can aid in making more informed decisions about MF investments. Here’s what you need to know:

• MFs have the discretion to manage their cash positions, often adjusting them based on market speculations.
• These cash positions are typically disclosed in holdings (the assets within an investment portfolio owned by an individual or entity) breakdowns. This means that the amount of cash in a portfolio is usually shown in a list of all the assets owned by an individual or organisation.
• Cash levels include cash equivalents which usually offer liquidity and a potential return of around 2%.
• For investors, cash levels can indicate market sentiment. For instance, cash levels exceeding 10% may suggest a bearish outlook, while 3% to 8% typically indicates a bullish stance. 

Let's say you have a mutual fund with a total value of INR 100,000. If the cash level in the fund is more than INR 10,000 (10% of INR one lakh), it might mean the fund managers are cautious about the market (bearish). If the cash level is between INR 3,000 to INR 8,000 (3% to 8% of INR one lakh), it could suggest the fund managers are positive about the market (bullish).

• Funds might also maintain higher cash levels for strategic reasons, such as seizing new investment opportunities or ensuring distribution payouts.

The role of cash levels in equity and debt mutual funds: A balancing act

Equity MFs and debt MFs are separate investment choices with unique attributes. Equity funds invest in publicly traded stocks, seeking long-term capital growth. In contrast, debt funds prioritise fixed-income instruments, offering stability and a consistent income stream. Let's delve into the significance of cash levels within equity and debt MFs.

• Equity funds - These typically keep around 1% to 5% of their total assets in cash, but some may go as high as 7-10%. Some funds prefer holding more cash when they can't find good stocks at favourable prices. Equity funds usually have less cash because they are designed for long-term investments.
• Debt funds – These, on the other hand, allocate more to cash and cash equivalents. They do this because the people who invest in these funds usually plan to take their money out sooner, so having more cash on hand makes it easier to give it back to them when they want it. Whether a fund should hold cash depends on the fund's strategy and market conditions, and it's a subjective decision made by fund managers.

Understanding mutual fund cash levels with industry experts

Cash levels in MFs are not static. They are carefully managed to align with an MF's objectives and market conditions. As investors, grasping how MFs handle their cash reserves is crucial. It equips you to confidently navigate the ever-changing financial markets. Gain insights from industry experts to make informed MF investments. Collaborate with India's fastest-growing brokerage to comprehend the importance of cash allocation in managing liquidity, risk, and returns. Take strides toward your financial objectives with a robust mobile and desktop platform accessible to all Indians. You can also download our app to get started. Happy investing!