Cash levels in equity mutual funds are at near-historic lows, the result of pressure from 401(k) plan sponsors and what had been a roaring bull market.
The average cash position in equity mutual funds throughout 1998 has hovered at about 5% on a monthly basis, according to data from the Investment Company Institute, Washington.
That number may begin to move closer to 6% now, said ICI spokesman John Collins, after being as low as about 4% for several of the past 12 months.
By comparison, the highest average position rose to 12.9% in October 1990, just before the Persian Gulf War, and remained above 7% in every month until May 1996, according to ICI data.
Not all equity mutual funds have lowered their cash positions. The more esoteric equity approaches -- small- and micro-cap stock, emerging markets, single country funds and some sector funds -- tend to hold more cash.
Surprisingly, 16 of the "pure" equity funds among the 100 most used by defined contribution plans held cash positions of 9% or more. The cash average for the 100 funds was 5.1%.
The data from Morningstar Inc., Chicago, may reflect cash allocations anywhere from the end of the second quarter on.
Many value managers had trouble finding stocks priced attractively enough to meet their disciplines in the first six months of 1998, said Mark Riepe, head of the Schwab Center for Investor Research at Charles Schwab & Co., San Francisco.
"Value managers were at 20% to 25% in cash earlier this year because they didn't want to buy stocks at the prices being charged. They basically had two choices: hang onto the cash or equitize it by buying, say, S&P 500 futures," Mr. Riepe said. "For some, hanging onto the cash was probably an expression of their depression about where the market might be going. Holding a higher cash position can be like making a small market timing decision for some managers."
Said Ivan Cliff, senior vice president at Callan Associates Inc., San Francisco: "If you're a very value-oriented equity manager, even a contrarian, up until recently, you had a very hard time because (stock) valuations were so high.
"Managers were not overtly timing the market but, rather, building cash as they waited for the market to slow and valuations to drop. They weren't so much selling out of the market as waiting to get into it. Some paid the price for building up too much (cash) too early."
'CASH IS A RESIDUAL'
Among the 100 equity mutual funds most used by 401(k) plans, the $5 billion Prudential Equity Fund, managed by Tom Jackson, had the highest cash allocation -- 20% as of June 30.
Mr. Jackson, a deep value manager, said, "Basically, to my way of thinking, that cash position is a residual."
Mr. Jackson said he is looking for cheap, value stocks and "if you can't find 'em, you can't find 'em. If there's a dearth of suitable stocks to invest in or if there's a big cash inflow, I'll hold the cash."
As his cash position rose as high as 25%, he said, many, but not all, of his investors agreed with his approach.
"It seems that the mind set of larger plan sponsors and institutional investors is that 'I pay you to buy stocks, so go buy stocks.' And institutional managers are in a situation where they say it's their job to set asset allocations and that cash messes up those allocations," he said.
"But my attitude is that 'If you don't like it, hire someone else.'
"I don't see any particular reason to compromise my style to get business on the books. My feeling is that there is a place for this (kind of management)."
Mr. Jackson's kind of value management led him to begin reducing his cash allocations quickly once the stock market turned downward in August. "Now there are a lot of cheap stocks out there. The average stock on the New York Stock Exchange dropped 45%, so there's no lack of things now to thumb through."
His cash level is down to about 5%, he said, and could go as low as 2%.
MERRILL FUND A PUZZLE
The $4.5 billion Merrill Lynch Growth Fund had the second-highest cash holding on the list -- 19% as of June 30.
Since the fund's stated objective is growth, consultants were somewhat puzzled by the high cash allocation.
The fund's manager, Arthur Moretti, was traveling and unavailable for comment, but he explained through company spokeswoman Susan Thompson that the cash position is "a residual of our bottom-up strategy, which is to put cash to work when it is consistent with our three- to five-year investment horizon."
The fund was fully invested in the fall of 1995, but since then, cash trended as high as 25% to 30% in 1996, and as low as the mid to high teens at times during the past three years.
Mr. Moretti's cash position, Ms. Thompson said, has moved "slightly downward" since the end of the second quarter, but she was unable to disclose the figure.
Other value funds most often used by 401(k) plans also had fairly high cash levels, as their portfolio managers waited for stock prices to come down to more reasonable levels.
The Merrill Lynch Basic Value Fund had a cash position of 14.8%; the Fidelity Low-Priced Stock Fund, 13.4%; Vanguard/Primecap, 13%; the MAS Value (Institutional) Fund, 9.6%; and the Dodge & Cox Stock Fund, 9%.
Dodge & Cox, San Francisco, regards itself as fully invested when its $4 billion Stock Fund has a cash position under 10%, said Ken Olivier, senior vice president.
As bottom-up stock pickers, Dodge & Cox's investment team allowed cash to rise for defensive purposes, he said, and as soon as the market began to move downward in August "it resulted in some bargains being out there. We're taking advantage of it."
The fund's cash position was 4.5% by Sept. 30.
As institutional managers, Mr. Olivier said, Dodge & Cox's philosophy is that plan sponsors are selecting stock funds for 401(k) plans because they want their participants to be in the market, not in cash.
"To get to the point of having a very high cash allocation in a mutual fund defeats what we think is the intent of plan sponsors in offering our fund," he said.
Callan's Mr. Cliff agreed institutional investors are increasingly concerned about the cash position in a mutual fund.
"That a fund has a fully invested status is becoming just as important as style discipline to plan sponsors," he said.
TRIGGER FOR DISMISSAL
Whether a mutual fund is fully invested is turning into a trigger for dismissal by plan sponsors, said Rick Reinking, vice president of consulting at Ibbotson Associates Inc., Chicago.
"In my opinion, high levels of cash are unacceptable. Plan sponsors expect the funds they offer to be fully invested, and it turns into negative news when they see a portfolio manager begin to build up cash. There's a certain segment of sponsors that will drop a fund now when cash rises too high. They are selecting funds on the basis of asset class, and cash dilutes the effect of that asset class choice," Mr. Reinking said.
But Callan's Mr. Cliff said plan sponsor reaction to cash positions changes.
"They tend to beat up a manager if he holds a lot of cash during a bull market, but look the other way when the market is down," he said. "It's not consistent and it's not fair, but it is human nature."
Holding a slightly higher cash position helped managers during the late summer market downturn, although not as much as commonly imagined, said Nola Kulig, a portfolio manager at Frank Russell Trust Co., Tacoma, Wash.
"We estimated that equity managers that held an average cash position of about 5% in the third quarter picked up about 60 basis points in return due to that cash holding. But that really didn't help active managers much at all compared to index returns," she said.
Mr. Cliff said there is a legitimate need for some cash in open-ended mutual funds to cope with redemptions.
Funds invested in asset classes in which stock liquidity can be a problem -- such as small-cap stock and emerging markets funds -- also may have to hold more cash than is typical, as their managers wait for liquidity to catch up with demand.
But for domestic large-cap equity funds from families that have established lines of credit or can borrow from other funds to meet redemptions, "there is no reason at all to hold a lot of cash," he said.