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Since mutual fund schemes are a bouquet of various investment avenues (Equity, debt, gold and cash) that you can invest in, in varying proportions, as per one's risk, age, and financial position, you get a fair diversification across asset classes that do not have a direct or positive correlation to each other, which reduces the overall risk of loss to the portfolio, particularly when there's a fall in one asset class.

As you probably know, every investment has risk associated with it. So, while different assets may react with different moods to the market fluctuations, a proper allocation across asset classes and investment styles could protect your money from significant ups and downs of any single asset class and scheme in the portfolio.

Basically, a healthy portfolio takes exposure to any/all asset class which does not gain or lose at the same point of time. As per the mutual fund classification norms, a type of fund is defined by the maximum exposure in terms of proportion to any asset class.

Table 1: How funds generally allocate their assets

Type of Fund	Proportion Invested
Equity	Allocates a minimum of 65% /80% investment made in equity & equity related instruments.
Debt	Allocates almost all the asset in the Debt & Money Market instruments depending on the Macaulay duration of the portfolio
Gold	Are ETFs/FOFs where the underlying asset is gold (95% invested in securities of a particular index)

(For Illustrative purpose only)

But if you notice the asset allocation pattern of any mutual fund scheme, which is stated in the scheme information document, some part of the fund is allocated to "Cash holdings."

Most fund managers, while constructing the portfolio of the fund and managing it, take exposure to cash within a range of 1%-10 %. While some other funds prefer to hold larger portions of their portfolios in cash because their mandate allows them to hold high cash levels if- and as per the analysis-good stocks are not available at desirable valuations.

Cash holding in a mutual fund is highly significant as it is a way of managing liquidity conditions of a scheme. Here are few reasons as to why it is important...

1. It allows the Mutual fund to pay the transaction fees, AMC's employees, and other operating expenses.

2. To be prepared to cover the cash redemption requests made and avoid the need to sell securities to meet redemption requirements.

3. Allows fund managers to do 'opportunistic' buying whenever they encounter value buying options as per the prevalent market conditions.

4. And most importantly, to protect the assets when there is an unfavourable environment.

The fourth point emphasises the fund managers' approach to high conviction funds and their ability to align buying decisions as per the prevailing market conditions. The more perceptive the fund manager, better the results.

Remember, equity funds are highly volatile because it invests in equity stocks of various companies from different market capitalisation segments and sectors.

There are many macro and micro economic headwinds at play that affect equity stocks. Hence equity funds carry extreme investment risks. But these funds do provide better inflationary-adjusted returns in the long run and are vehicles meant for long-term investments. So usually such funds have a low cash-holding level as compared to debt funds.

Currently, the markets have been wading through the turbulence of overall economic slowdown, leading to sharp corrections, yet offering value buying opportunities for fund managers. But what has been seen is that the fund managers have increased the cash holding proportion in schemes.

From March 2019, the percentage of cash holdings differs, wherein some funds with barely 1% previously have increased their holdings by 4%-5% or more and some have reduced as seen in the table below.

Table 2: Cash holding levels

Scheme Name	Market Value (Cr.)	Month's Total Cash Holdings (Cr)		% Holdings In Aug-19	Growth Seen Over 6 Months (%)
		Mar-19	Aug-19
ICICI Pru Bharat Consumption Fund-2-(G)	1650.22	94.16	101.47	6.15	0.08
ICICI Pru Value Fund-10(G)	848.68	29.24	52.12	6.14	0.78
ICICI Pru Value Fund-12(D)	4333.63	101.18	253.18	5.84	1.50
Aditya Birla SL Pharma & Healthcare Fund-Reg(G)	307.95	0.00	17.81	5.78	0.00
ICICI Pru Value Fund-18(G)	807.79	57.80	39.78	4.92	-0.31
Axis Small Cap Fund-Reg(G)	2916.92	67.64	135.18	4.63	1.00
ICICI Pru Bharat Consumption Fund-5-(G)	197.14	6.47	8.10	4.11	0.25
ICICI Pru Growth Fund-1(DP)	626.93	35.63	25.15	4.01	-0.29
ICICI Pru Value Fund-13(D)	4256.86	60.21	164.96	3.88	1.74
ICICI Pru Value Fund-17(G)	1175.81	67.47	44.72	3.80	-0.34
IDBI Healthcare Fund-Reg(G)	203.7	28.56	7.67	3.77	-0.73

Note: Total cash holding include cash and cash equivalence, deposits, treasury bills, warrants and units of domestic mutual funds
​Data as on September 13, 2019
(Source: ACE MF)

And some of the funds that were launched within the last six months have high cash holding like the Tata Nifty Pvt Bank ETF (was launched last month) have invested all its assets in cash.

Table 3: % of cash holding of recently launched funds

Scheme Name	Market Value (Cr.)	Aug-19
Tata Nifty Pvt Bank ETF	10.50	100.00%
Parag Parikh Tax Saver Fund-Reg(G)	15.00	19.54%
ICICI Pru MNC Fund(G)	1948.66	12.26%
Kotak Focused Equity Fund-Reg(G)	2465.36	11.07%
Quantum India ESG Equity Fund(G)-Direct Plan	22.36	9.43%
Principal Small Cap Fund-Reg(G)	506.00	5.20%
Union Focused Fund-Reg(G)	227.65	3.03%
Mirae Asset Midcap Fund-Reg(G)	1320.41	4.41%
ITI Multi-Cap Fund-Reg(G)	105.05	2.42%
Mirae Asset Focused Fund-Reg(G)	4748.25	1.64%
ICICI Pru Bharat Consumption Fund(G)	2933.34	1.35%

Data as on September 13, 2019
(Source: ACE MF)

When there is an increase in the percentage of cash holdings, it indicates that fund managers are being bearish (read cautious), till the markets' tides change to a favourable buying environment.

But when fund managers increase cash holding in rising markets, there is an advantage that a fund's beta (a measure of volatility) falls on moving to cash during market highs, lowering risks. On the flip side however, this strategy leads to losing opportunities during market rallies, as beta levels rise high and leads to fast stock run-ups in good market conditions and heavy losses in a bad market.

For investors, looking into cash levels can signal a collective sense of fear or optimism about the broad markets. That's because the cash holding in a fund plays a significant role in determining its performance. To be under-invested at the beginning of a rally could lead to underperformance. Similarly, being over-exposed could hurt the fund if the market is about to fall.

For instance, if aggregate mutual fund cash levels are more than 20%, it would indicate that fund managers are being bearish about the market and holding back on making new purchases. Whereas if the cash levels are in the normal range of 10%, it indicates fund managers are deploying the money--putting it to work to achieve the stated objective of a scheme.

However, it is challenging for a fund manager to maintain the fine balance between cash holding and stock investments. So, while some fund managers remain underinvested at the start of a major rally, others are overexposed just as the market is about to nosedive.

But, for an investor, to look into cash holdings of a fund as an indicator to make a smart investment is not a right approach because that would mean timing the market, which is a hazardous approach.

As mentioned earlier, fund managers increase or decrease the cash holding levels for other reasons as well. So, when selecting worthy funds, it is important for investors to focus on the qualitative and quantitative parameters and chose ones that are congruent to their financial goals, risk ability, and financial positioning.

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