The Mutual Fund Show: Cash Allocation In Equity Mutual Funds
Indian equity mutual fund managers held cash worth over Rs 90,000 crore at the end of September, according to Morningstar data.
The cash allocation in equity mutual funds moves in cycles and change is influenced by opportunities in the equity markets, which is in line with the investment style of fund managers, according to experts.
"In the past, we have seen that there have been cycles when the cash allocation suddenly goes up and others when the allocation suddenly moves down," Himanshu Srivastava, associate director–research at Morningstar India, told BQ Prime.
"It's largely when the managers are not able to find enough opportunity in the market, say a stretch valuation, when we see cash levels going up in the mid and small-cap segment," he said.
Indian equity mutual fund managers held cash worth over Rs 90,000 crore at the end of September, according to Morningstar data, as geopolitical crises and soaring bond yields fuelled a risk-off sentiment.
Currently, several small and mid-cap fund managers are holding cash of more than 5% of assets under management, said Kaustubh Belapurkar, director–research at Morningstar India. This is usually done when fund managers are uncomfortable with valuations or are dealing with inflows that are unanticipated, he said.
The nature of the underlying stocks that these schemes invest in has also forced fund managers to look further afield to find stocks to invest in.
"The number of stocks in portfolios is going up, specially in the mid and small-cap segments," Srivastava said. "That could be because of capacity constraints and because of the flows."
He also noted that liquidity in the small-cap segment could be challenging when the tide is not in their favour. "For a fund manager, it is important to maintain liquidity in a portfolio," he said.
During market swings, fund managers in the hybrid space have the flexibility to use that to safeguard the fund, move away from riskier assets, liabilities, and expand some exposure to fixed income, he said.
Watch The Full Interview Here:
Edited Excerpts From The Interview:
We have seen considerable investments by retail investors into mutual funds over the past several months. And, over the past three months, domestic institutions have been deploying even as foreign institutions are exiting. How much cash are the equity mutual funds holding? What does that tell you?
Kaustubh Belapurkar: I think that's a very interesting data point to look at, because it gives you a pulse of what's really happening, what professional money managers are thinking.
And, to answer your question in terms of numbers, equity mutual funds are in total holding about Rs 90,000 crore in cash right now. Obviously, at any point of time, you would see a reasonable amount of cash because you know, there is always money in dry powder to deploy, but I think over the last six months, this number has inched up. I think, that's a pretty sizable amount of sort of money that is lying.
That's at the end of September.
Kaustubh Belapurkar: That's right. So, I think it's a pretty reasonable number to deploy from a manager's perspective. I think what managers will look to do, not go the whole hog immediately. I mean, there's obviously a lot of moving parts right now, be it locally or globally in terms of obviously, geopolitics and other things. So, it will take some time to really do that, and especially when you think about small and mid caps.
If we are talking about Rs 90,000 crore in the context of equity mutual funds, we are talking about close to 5% or thereabouts. So, how does that compare to periods in the past, where you have seen slightly elevated levels?
Himanshu Srivastava: How does the market move? It moves in cycles. So, in the past we have seen that there have been cycles when the cash allocation suddenly goes up and others when the allocation suddenly moves down. It's largely when the managers are not able to find enough opportunity in the market, say a stretch valuation, when we see cash levels going up in the mid and small-cap segment.
Normally, what also happens is, if the portfolio has grown quite significantly, if the size of portfolio is big, deploying that kind of cash immediately becomes a challenge. These are also some of the scenarios when we see that the cash allocation of fund might move up. Then there are certain funds, which traditionally maintain a relatively higher degree of cash for an elongated period of time.
Obviously, one other reason is not being able to find enough opportunity in the market, which is in line with the investment style. But historically, I think it's very difficult to say that cash levels were higher or lower earlier. I think it depends on which part of the market cycle we are in, and at that point of time where the cash levels should lie.
Mid and small-cap funds are currently holding elevated amounts of cash. How much? And the reason is seemingly very obvious to us sitting here, but can you break that down?
Kaustubh Belapurkar: I haven't looked at the granular numbers per fund, but I think traditionally, what we have seen directionally is that a lot of mid and small caps are probably holding much more than that 5%, because remember, when you have an average 5%, a lot of large-cap managers traditionally would typically be almost fully invested, (except for) may be an odd 2% of cash.
And, there are several reasons for that. I think Himansu alluded to one, that valuations are obviously a little expensive. Also, the other thing that we have seen in terms of the flows. Investor money has gravitated towards small and mid caps, and it has not just been through your SIPs, which managers are typically geared for, but there’s a lot of fresh money coming. And managers are also being much more prudent, which is right, because you don't want to be buying anything and everything. You take your time, deploy that cash more judiciously. And that may not necessarily only be a function of what's happening in the market, but because obviously, we want to move the counter slowly and things like that. So, I think that's what is also driving some (levels). I wouldn't say it's extremely elevated, but it's probably higher than what you have seen in recent years.
What according to you are the most interesting trends that you have picked up when you study fund manager behavior over the last few months?
Himanshu Srivastava: Over the last few months if you look at certain portfolios, especially if you are talking about mid and small-cap segment, and if I have to specifically talk about small-cap segment, I have seen that the number of stocks in the portfolio is gradually going up. That could be, slightly because of capacity constraint or you are getting a lot of flows. And, it's not really bad unless and until it reaches a certain extent where you feel that it becomes unmanageable. But at the same time, for a fund manager, it's also important to maintain liquidity in the portfolio and have a very top concentrated portfolio or higher allocation to one, or two stocks, or maybe three stocks. We know that liquidity in the small-cap segment could be very challenging when the tide is not in his favour. So what managers are doing is to incorporate these extensive flows that are coming into their funds. I think they are expanding the number of stocks in the portfolio so that they maintain liquidity and there is enough diversity. So, they are slightly on the safer side at this point in time. This is one of the trends that we have picked in recent times.
Kaustubh Belapurkar: Absolutely, and I think that also leads to the other factor that a lot of small-cap funds have soft closings, because they acknowledge that capacity can potentially be … and which is a great thing too because it's healthy, it's in the best interest of investors. And, it's probably the worst, if you think of it as a businessman. It is the worst thing to do to turn away money when everyone is trying to come to you. That's probably the most prudent thing to do from an investor’s perspective, because you are not finding, may be the most amount of opportunities in that space. Valuations are expensive, or your assets are ballooned, and also somewhere, just setting the investor expectation also. It’s not going to be the case going forward every year and year because, you know, the investors tend to gravitate towards short-term returns and that's where a lot of the money is coming in. So, I think setting the context for the investors is also important, which is happening and which is great.
In the hybrid segment, fund managers have the ability to change the allocation of their funds, either towards equity or towards fixed income whichever looks attractive. What are the trends that you are seeing in the portfolio construction there?
Kaustubh Belapurkar: It's actually very interesting. So we looked at three-year average net equity exposure. Typically there are two categories where you will see a fair bit of flex on the equity exposure—obviously balanced advantage funds and little bit on the multi asset side.
And I think, what we're seeing is that the current net equity exposures are actually very close to three-year average, which is interesting. May be the needle might move in the next few months. A lot of them run into evaluation models and things that might look to reduce some exposure. Also, because the fixed income means are looking great.
So, when you say that they are at three-year averages, they are slightly elevated and they could go down, going forward. And, there could be a little bit of selling there. But I think fund managers may decide to take some profit off the table. But what is the size that we are talking about Kaustubh, in terms of the size of the segment?
Kaustubh Belapurkar: If my memory serves me right, almost Rs 3 lakh crore in assets between these two categories. And probably, our cash levels and net equity exposure can range anywhere between 50% to 60% with a lot of these strategies. I mean you take off 5% to the math. You won't see a sharp drop, but there could be some.
Do you generally see very sharp swings in portfolio management? No, it's a gradual shift over a period of time. In your experience, what kind of period do you see these shifts take place in?
Himanshu Srivastava: There are periods normally when you see fixed income giving slightly better, or I would rather put it like that way—the risk-reward profile is better in the fixed income segment than on the equity side, which is the case right now.
You know, you see a lot of geopolitical tensions or what is happening globally and it does impact Indian markets. Obviously, the Indian market has not been that impacted because we are getting lot of flows from DI (domestic institutional) investors but at the same point in time, you can never be very sure as to when the tide could turn. These are some of the perfect scenarios where a manager in the hybrid space has the flexibility to use that flex to safeguard the fund, move slightly away from riskier assets, liabilities, and expand some exposure, perhaps allocate some exposure to fixed income. So, I think this is the perfect time when we can expect managers to do that.
Some people—particularly in the broader end of the spectrum—talk about valuations being stretched and fund managers are understandably holding cash. Do you take a call to reduce SIPs, or do you keep it going, saying that it doesn't really matter, as you are looking at the next five years anyway?
Kaustubh Belapurkar: That's a very important point. With SIPs, the whole intention is you do nothing about and that's how it should be, because, the whole concept of autopilot investing is exactly that—that you're not going to use an override function unless something has dramatically changed in the world. So, the whole idea is to continue with that. But also, set your expectations correctly, because I think what I was alluding to earlier is that, a lot of investors get swayed by recent returns, and they extrapolate that this is what I am going to get in the future. That's not going to be the case. Even you are coming through the SIP route, be ready for drawdowns or, negative periods, probably for a prolonged period of time. We have seen that happen, especially in the small and mid-cap space. So, I think that's something you need to be behaviourally attuned to. Obviously if you have the right investing horizon, when you invested in a segment like smaller mid caps, just stay the course. But you know, there will be volatility in between, it might heightened tension, don’t worry about it.
Over the last nine months or so, you have seen a sharp outperformance by small and mid caps. And even though actively managed funds have underperformed, especially in the small-cap category, the benchmark has still seen significant double-digit returns, which would have skewed portfolios as well. Is this the moment to rebalance, if you have seen that skew?
Himanshu Srivastava: If your asset allocation requires you to be say X% in small and mid cap and that X% has become X plus 5% or 10%, then obviously, this is a time when you can rebalance your portfolio, you should be looking at doing that. The idea is, obviously you should balance that kind of portfolio, but it should not be because of some fear or something. It should be because that is the requirement of the asset allocation.
Ideally, if you are investing and if your asset allocation suggests so, you should continue to stay the course, as Kaustubh mentioned, because that is what long-term investing is all about. It is small caps over the recent times that have been very, very volatile. We can see sharp surge, we can see sharp drawdowns to ride through that cycle, but the idea is to stay put.
Kaustubh Belapurkar: As Himanshu rightly said it is never zero or one game. So, let's make those graded adjustments to your portfolio and the same thing which an allocation fund would do that. They are never going zero on equity for instance. They will always move within a band, because equities in small and mid caps are great long-term wealth creators. We need to stay the course.
