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Rushing to lose

Prasunjit Mukherjee studies the cash position of equity funds during the bull phase and after the correction to raise some worrying questions.

Print Edition: April 17, 2008

Prasunjit Mukherjee
Prasunjit Mukherjee

When we invest in a mutual fund, we expect the fund manager to manage our money in the best possible manner. After all, fund managers are supposed to have “smart” strategies, follow global systems and use complex evaluation tools. Or else why should we pay a fund manager a fee of 2.25% every year.

To evaluate if fund managers are indeed using smart strategies or just following the herd we looked at how effectively funds used the cash in their corpus when markets were running high and when the crash came. The fund category we studied was the equity diversified family and the stock market index we considered was the broader BSE 100.

In February 2007, when the BSE 100 index was around 7233, the 94 funds in the diversified equity category had almost 7.3% of their total assets in cash (including cash, cash equivalent and debt). By the end of the year in December, the BSE 100 had shot up to 11154 while the cash holdings of these funds fell to 5.45%, indicating a sharp acceleration in moving from cash to equity. The switch was perhaps prompted by the desire to catch up with rivals which were launching new funds and investing as soon as possible.

Thus, fund houses kept on investing larger amounts into equity as the markets went up. Not only were the older, more established funds rushing to invest spare cash but even the new funds were looking to get fully invested as fast as possible.

Clearly, fund managers thought the party was going to last forever. They believed that if they did not board the equity wagon then, the wagon was gone for good. The picture changed after the savage correction in January this year. By the end of February, the BSE 100 had tumbled to 9440 points. Inexplicably, the cash holding of diversified equity funds (now numbering 109) moved up almost 2 percentage points to 7.5%. Normally when a fund has a large cash position, it is often a sign that it sees few attractive investments in the market and is comfortable sitting on the sidelines. But this does not explain the current behaviour—at least not entirely.

My questions to fund managers are simple: How can the well researched picks you found attractive when the Sensex was above 20000 be not worth buying when the index is 25% lower? And, how can a new fund offer get fully invested so quickly? What exactly is their comfort level in stock prices?

I know the stock answer from fund managers would be that “investors give us money to invest, not to put in cash”. But investors want their money to be managed, not merely invested. A me-too investor is just a broker, not a fund manager. The momentum investing by equity mutual funds almost did away with this distinction in 2007.

Prasunjit Mukherjee heads Plexus Management, a Kolkata-based mutual fund consultancy. 

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