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HOW MUCH CASH DOES YOUR MUTUAL FUND CARRY AND WHY?


Let us start off with the premise there are three primary asset classes, stocks (equities), bonds and cash. Hard assets such as real estate are also prominent today. In a typical mutual fund, the fund manager will almost always hold at least some cash. 

 

The primary reason is a mutual fund is required to redeem assets upon demand, subject to a 3 business day settlement period. Should you request the sale of all or part of your mutual fund before close of business on say a Friday, three business days later, in this case the following Wednesday, the proceeds of the sale (redemption) will be in your account at the investment dealer. Closed end mutual funds may have more restrictive redemption provisions.

 

Should a fund company not have adequate cash on hand in a given mutual fund to meet  redemption requests, they may be required to sell assets in the fund or borrow to be able to return your capital. Generally this would be a rare and prolonged period when the fund is in net redemptions, ie: more money flowing out than into the fund. In all but such extreme circumstances, the mutual fund company will normally return your money from the cash they carry on hand.

 

Cash positions may be there for a number of other reasons. The manager may not be able at a given time to find securities which can be purchased at attractive prices, so may be waiting for such opportunities. Accumulated cash may also be flowing into the fund due to a period of very strong investment performance. The cash may also be accumulated as the result of the sale of certain securities in the portfolio, with the manager taking some profits or perhaps doing some tax loss selling before year end. The manager may also believe a correction (decline) in the market may be coming, so elects to increase the cash position of the fund in an attempt to better preserve capital so he/she may buy at lower prices.

 

Cash flows in and out of mutual funds on a daily basis. Suffice to say the cash position in a mutual fund is a moving, rather than static target. Some mutual funds set out in their prospectus how much cash can be held by the manager in the fund. For example, the XYZ fund may be mandated to be fully invested. Typically this would mean no more than say 10% could be held in cash.

 

Mutual funds which  have this type of mandate typically believe the role of the fund manager is to invest in the asset class they specialize in, not have money sitting in cash. Other fund managers may believe they should manage the client money as if it were their own. In this sense, if the manager is uncomfortable with the current state of the market, a much higher than ususal cash position may be held.

 

Keep in mind mutual funds charge management fees. So the argument is always out there the manager should be fully invested in the asset class they manage, not sitting in cash, to justify their fees. The counter argument is a manager is paid to exercise their judgement, so their personal views come into play, which may be right or wrong over a given period.

 

It is therefore important to know the mandate of the fund as well as philosophy of the fund manager, when selecting a mutual fund for your portfolio.

 

The comments and opinions expressed are solely those of R.W.(Bob) Davies, CFP and not those of Manulife Wealth Inc.  E & O excepted. For more information contact Bob at robert.davies@manulifewealth.ca


Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the prospectus before investing. Mutual funds are not guaranteed, their values change frequently, and past performance may not be repeated.