Mutual funds holding cash: Is high cash balance a red flag for investors? Experts explain

A mutual fund primarily invests in stocks, bonds, or commodities, but not every rupee in its portfolio is always deployed in these assets. The fund may maintain a small allocation to “cash and cash equivalents”, a line item that often raises questions among investors.

Does a higher cash balance mean the fund manager is bearish? Is it a sign of caution? The answer is more nuanced. Here’s what experts have to say on this.

What are cash and cash equivalents in a mutual fund portfolio?

Nitin Agrawal, CEO, Mutual Funds by InCred Money, explains, “Cash and cash equivalents refer to the portion of assets parked in treasury bills, overnight funds, tri-party repos (TREPS), and other highly liquid, short-duration instruments, assets that can be converted to actual cash at short notice with negligible loss of value.”

Vaibhav Porwal, Co-founder of Dezerv, points out, “It is rarely idle money. It earns an overnight or near-overnight yield.” But investors should not assume the entire figure reflects an active investment decision.

“It is not always discretionary cash. It can include money tied up in trade settlements, dividends receivable, or fresh inflows that have arrived but are yet to be deployed.” Porwal mentioned.

Why do mutual funds hold cash?

Fund managers maintain cash for both operational and investment-related reasons.

According to Abhishek Bisen, Head – Fixed Income, Kotak Mahindra AMC, “Mutual funds may maintain a certain level of cash and cash equivalents primarily for operational reasons. These balances help meet day-to-day liquidity requirements such as investor redemptions, expenses, and portfolio rebalancing without disturbing the underlying investment portfolio.”

Thomas Stephen, Director & Head – Preferred, Anand Rathi Share and Stock Brokers said, “Fund managers may increase cash levels when they believe equity valuations have become stretched or when suitable investment opportunities are limited.

Rather than deploying capital into stocks that appear expensive, they prefer to wait for more attractive entry points, allowing them to invest when valuations become more reasonable.”

Porwal adds that cash serves as “dry powder” during market corrections, highlighting that some managers deliberately keep cash so they can buy into a sharp fall.

Is a higher cash allocation good or bad?

Neither.

As Stephen mentioned, “From an investor’s perspective, higher cash holdings can reduce portfolio volatility because cash is largely insulated from equity market fluctuations. As a result, funds with relatively higher cash allocations may experience smaller declines during market downturns.

However, the same cash allocation can also act as a drag on performance during strong bull markets, as the uninvested portion does not participate in equity market gains.”

Should investors check a fund’s cash holdings before investing?

Yes, but only as one part of the overall evaluation. Agrawal said, “A fund’s monthly factsheet discloses its cash-and-equivalents percentage, and it’s worth tracking the trend over a few months rather than a single snapshot.”

Stephen echoes this view, “Start by reviewing the monthly factsheet to track cash trends over time, and read the manager’s commentary to understand whether the position reflects valuation concerns, opportunistic intent, or liquidity needs.”

Bisen also cautions against reading too much into cash levels alone. “Cash holdings, in isolation, are difficult to interpret and often do not provide meaningful insight into a fund manager’s market view.”

Is there an ideal cash holding benchmark for funds?

There is no universal benchmark because cash requirements vary across fund categories and investment styles.

“There’s no such ideal range, but for equity funds up to 5% of cash position is often for purely operational reasons,” Agrawal observed.

According to Stephen, for debt funds, holding cash and near-cash instruments is a routine part of portfolio construction and liquidity management. “Similarly, in hybrid funds, cash should be assessed along with the fund’s overall equity and debt allocation rather than as a standalone metric,” he noted.

Porwal explains, “Faced with the same cautious view on the market, one manager may choose to stay fully invested and ride it out, while another may raise cash because they cannot find opportunities they like. Neither is wrong.”

When should investors be concerned?

A temporary spike in cash is generally not a cause for concern. However, persistently elevated cash holdings without a clear explanation deserve closer scrutiny.

“For diversified equity funds, cash levels of around 5-10% may simply reflect tactical positioning. However, if cash remains above 15% for an extended period without a clear investment rationale, investors should evaluate whether the fund manager is struggling to deploy capital effectively or whether the fund’s investment strategy has become overly conservative,” Stephen stated.

Agrawal also points to a rare condition – negative cash holdings. “This may occur during rare market stress or a major credit event, indicating that the fund is unable to meet redemptions from its own liquid assets and is instead leaning on debt, often because the rest of the portfolio holds illiquid securities that cannot be sold at fair value to raise cash,” he concluded.