MarketWatch columnist Chuck Jaffee's Stupid Investment of the Week is any stock fund with 40 percent of its assets in cash.
One phrase that keeps coming up in the current market environment is that “cash is king.”
But when it comes to mutual funds that own stocks, too much cash — the point where more than 40 percent of the portfolio is in cash instead of the stocks the fund is supposed to hold — makes a Stupid Investment of the Week.
That’s particularly tough to see right now, where if you sorted funds based on the percentage of their portfolio in cash, the general-purpose issues that are heaviest in cash would also be the ones topping the year-to-date performance charts.
The problem is that they’re getting ahead, in most cases, by failing to live up to the reasons why you bought the fund in the first place, and their purportedly good returns are actually overpriced.
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Stupid Investment of the Week highlights the concerns and characteristics that make a security less-than-ideal for the average investor, and is written in the hope that showcasing trouble in one situation will make it easier to root out problems elsewhere. While obviously not a purchase recommendation, the column is not meant to be an automatic sell signal.
That’s distinctly true in the case of funds with big cash slugs, as there are some cases where the move is appropriate and in keeping with investor expectations, and a knee-jerk reaction would throw those exceptions out along with the rule breakers.
According to investment researcher Morningstar, there are three dozen equity funds where the cash portion of the portfolio runs from 40 percent on up to 100 percent of assets.
Some get a pass because of the nuances of their strategies, while others are doing precisely what they told shareholders might occur in bad market conditions.
Then there’s the group that despite chart-topping recent results are letting investors down.
To see how a fund could top the charts but be a bad idea for investors, consider the reasons most investors purchase an equity fund, specifically to get representation in the market segment covered by the fund.
In other words, if you bought a fund like Reynolds Blue Chip Growth — where the self-proclaimed long-term strategy is “to emphasize investment in ‘blue chip’ growth companies — you were expecting the fund to hold more than 0.57 percent of its assets in those kinds of stocks.
With the fund being 99.43 percent in cash as of Sept. 30, and carrying an expense ratio of more than 2 percent, what you have is an expensive money-market fund that is failing to do the job you bought it for.
“In this day and age, when so much is invested according to advisers’ recommendations on style and market-cap exposure, I think that mutual-fund managers running equity funds should be at least 85 percent invested in stocks,” said Mark Salzinger, editor of the No-Load Fund Investor newsletter.
He added: “Based on what a manager does, you can see cases where the equity position drops as low as 70 percent of assets, but once you go below that level, there either needs to be a good reason for it, or you’re paying stock-fund prices on what amounts mostly to being a Treasury or a money-market fund.”
By itself, holding cash is fine, particularly in current market conditions.
There are some times when holding a high percentage in cash makes some sense from a fund-operations standpoint. Currently, for example, fund redemptions are running at or near record levels, and managers may want to hold higher-than-normal levels of cash in order to process redemptions without having to unload securities. That would explain why an ordinary stock fund might be as much as 10 percent cash in the current market.
And some fund strategies — specifically those using futures extensively — may wind up looking like there’s a lot of cash on hand when the truth is a bit different. The proof comes in the performance.
The problem is when an investor thinks they are buying an equity fund and getting something more like a cash fund instead. Basically, every domestic stock fund that is truly cash heavy — rather than heavy due to a futures investment strategy — ranks in the top 3 percent of its peer group. The ones that have a high cash structure due to the trading of futures — such as Rydex Russell 2000 2x Strategy fund which shows up as having more than 50 percent cash even though the index itself is completely stocks — are down at the bottom of the performance chart.
That’s why the Prasad Growth Fund is 98.6 percent cash and ranks in the top 1 percent of the world stock fund category, but the highly leveraged ProFunds Ultra International is 91.3 percent cash and ranks at the very bottom of the foreign large-cap blend group.
Then there are the funds that said cash was a part of the strategy. In this case, the investor presumably was buying the mutual fund for old-fashioned reasons, namely to get professional management and diversification at a reasonable price. They are letting the manager do the asset allocation, typically, rather than making their own decisions about which categories to put their money to work in.
Gabelli ABC Fund, for example, makes it clear that it might tilt toward Treasury securities depending on market conditions, while Counterpoint Select notes that “Cash may be held in the absence of a compelling alternative.” Each currently holds 60 percent of their assets in cash.
By comparison, there’s nothing in the prospectus of Touchstone International Growth Fund that would lead an investor to expect a 45 percent cash stake.
Even in some cases where an investor might expect a portfolio manager to go to cash, there’s a real question as to whether it makes sense to give a manager that kind of leeway. The PMFM Managed Portfolio, according to its Web site, is currently 100 percent in cash, but the fund’s documentation makes it clear that management will be defensive during bad market periods.
The fund has lost more than 5 percent year-to-date, but ranks at the top of the large-blend category, according to Morningstar. But with a 1.87 percent expense ratio, an investor clearly would have been better off sticking with a money fund or putting the money in a savings account.
“There’s nothing wrong with going to cash,” Salzinger said, “but it’s a problem when you put together an asset allocation, buy an equity fund to make that strategy happen and get exposure to equities, and then you wind up getting something else. You may be getting better performance than in other funds, but you’re not getting what you actually paid the manager for.”
Chuck Jaffe is senior columnist for MarketWatch. He does not own or hold short positions in any securities covered by Stupid Investment of the Week. If you have a suggestion for Chuck Jaffe’s Stupid Investment of the Week or a comment about this week’s column, you can reach him at firstname.lastname@example.org or Box 70, Cohasset, MA 02025-0070.