In Many Funds, Cash is Kind-Of King

SAN FRANCISCO – Some stock mutual-fund managers have such large cash positions in their portfolios, they might as well keep bankers' hours. But if you own these funds for their managers' ability to choose stocks, not to make market calls, then cash might not be king after all.

Most funds hold some cash, a byproduct of new money flow and as a means to cover redemptions without having to sell holdings. Diversified U.S. stock funds have about 4 percent of assets in cash on average, according to investment research firm Morningstar Inc., which in the money-management world essentially equates to being fully invested.

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It's when cash rises above 10 percent of assets that hard questioning begins.

"I don't think it's appropriate for them to be sitting in cash, charging their management fee, when they're not doing anything with it," said Kacy Gott, a principal at Kochis Fitz, a San Francisco-based financial adviser. "I do not hire managers to make that decision."

Financial advisers' ire is particularly strong about funds' cash. Advisers allocate client portfolios among asset classes, including cash. A fund that's rolling in dough upsets the plan.

"If I'm allocated say, 20 percent to domestic small-cap, and it turns out that a manager is holding 25 percent of his portfolio in cash, then my allocation is off," Gott said. "Your efforts are being undermined by that manager."

Cash as cash can

Fund managers park a portfolio in cash for a variety of reasons, and investors need to determine if levels are high by circumstance or by design, said Roy Weitz, founder of FundAlarm.com, the watchdog Web site.

"Investors need to do a bit of homework," he added. "If they're concerned about the extra cash, see what the manager's practice has been."

For some managers, excess cash is an anomaly, a residual of money flows or stock trades that has yet to be invested. For others, holding cash is a calculated response to adverse economic or market conditions. Keep powder dry, this thinking goes, and scoop up bargains later.

"We consider cash to be a strategic asset to the fund," said Larry Pitkowsky, co-manager of the Fairholme Fund (FAIRX) , which takes a strict value-driven approach to investing. "It gives us the firepower to be opportunistic and put money to work at advantageous times, which is good for our shareholders."

Fairholme's cash levels typically exceed 20 percent of assets, and at the end of March about one-third of the portfolio was liquid. The fund managers since have put money into the market after the recent declines, Pitkowsky said, and cash is now below 25 percent.

"It has not held back performance," he said. "It's not such a shabby return, cash, at the moment."

Cash drags on return only when stocks are going up. In volatile periods such as now, and with money-market yields pushing 5 percent, cash is attractive versus both bonds and stocks.

Better-known funds with managers who are wielding large cash positions include Quaker Strategic Growth (QUAGX) , which had 50 percent of assets in cash instruments at June 30, FPA Perennial Fund (FPPFX) and Yacktman Fund (YACKX) , both about 20% in cash, and three offerings from American Funds: Investment Company of America (AIVSX) and Amcap (AMCPX) , with about 15 percent cash, and American Mutual (AMRMX) , at almost 14 percent.

"There are periods when cash ends up being a better alternative to generate long term growth of capital," said Drew Taylor, a vice president at Los Angeles-based Capital Research & Management Co., parent of American Funds.

"Instead of fully invested, were 'fully managed.'" Taylor added. "So we are managing every dollar to its objective. Cash is an alternative investment that we have. If a stock idea doesn't give us a good feeling that it will generate a better return than cash, we're going to hold cash." At most American funds, he noted, a low cash level is between 5 percent and 8 percent of assets.

Dollars and sense

Money managers and financial advisers aren't about to stop haggling over funds' cash, so it falls to shareholders to determine if they're comfortable with the approach a fund follows.

Harold Evensky, a financial adviser in Coral Gables, Fla., said a fund's cash level is important, and among the criteria he observes in choosing a manager. But he added that a high cash level isn't reason enough to dismiss a manager out of hand.

"An investor needs to understand why the manager has a big cash position and decide whether that's palatable or credible, not merely reject them," Evensky said.

"If a manager has a consistent discipline of not paying for a stock unless they can get a certain discount to intrinsic value, and they let cash build, that's okay," added Russel Kinnel, Morningstar's director of fund research. "The downside can be that you miss a rally, and that's a big cost."

Indeed, the market-timing aspect of an outsized cash position is unsettling. Said Kinnel: "There are few managers I would trust with holding cash as a market call."

Mark Balasa, an investment adviser in Itasca, Ill., is even more adamant on that score.

"If I see high cash, especially if it's persistent, that would be a big black mark," Balasa said. "Fund managers' ability to time the market historically isn't any more promising than anyone else."

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