Stock mutual funds can hold cash for lots of reasons, from meeting redemptions to buffering the effects of a downturn. If you’re worried about a market decline, you’re probably interested in a fund that has a good-sized cash stash. But it would also be good to know if a fund actually uses that cash well. After all, a fund that raises cash and misses a big rally won’t make you or your clients happy.
The average stock fund holds 3.2% of its portfolio in cash, according to the Investment Company Institute. We looked at funds that had, as of their most recent update, at least 10% of their portfolio in cash.
Then we looked at the fund’s performance over the entire market cycle from the beginning of the last bear market on October 9, 2007. The Standard & Poor’s 500 stock index has gained an average 6.93% a year since then, despite the worst bear market since the Great Depression.
Few fund managers will admit to timing the market, but some funds let cash build up if they can’t meet investments that meet their criteria. And even that doesn’t guarantee a better outcome. Lots of cash and lots of financial stocks still resulted in heartbreak for investors during the Great Recession. So we also looked at the fund’s maximum drawdown – its peak-to-trough loss – as well as the length of time the fund took to recover. The S&P 500 lost 55.3% in the bear market, including dividends, and didn’t recover until April 2012.