Mutual funds' cash reserves at 27-year low
Monday, February 21, 2000
By CHET CURRIER
BLOOMBERG NEWS
If the U.S. stock market ever drops out of the sky,
most mutual fund managers won't be packing
parachutes.
The cash reserves that stock funds keep in short-term
interest-bearing investments are down to a 27-year low
of 4.3 percent, according to the Investment Company
Institute.
This reserve promises to stay skimpy for the
foreseeable future. Because of the pressures on them to
squeeze out the best performance numbers possible,
many stock fund managers wouldn't dare increase their
reserves significantly even if they thought it was a good
idea.
This isn't all bad, and it doesn't necessarily portend
disaster. You can argue that the policy of staying "fully
invested" that many funds follow today has helped
prevent bear markets.
What's more, fund investors, unlike fund managers,
have built up a healthy reserve -- a record $1.6
trillion-plus in money market funds, almost 20 percent
more than they had a year ago. In theory at least,
investors could move some of this money into stock
funds when prices fell, giving stock managers the cash
they would need to bid for stocks.
Even so, the stock funds' situation is enough to unsettle
anybody who's been feeling all snug and warm in the lap
of the bull market.
"How comfortable is cash?" says Steve Leuthold,
chairman of the investment research firm Leuthold
Group in Minneapolis. "Well, consider that in a mere 10
days following the 1987 crash, net redemptions
amounted to 4.5 percent of equity mutual fund assets."
Simple math suggests that if fund investors redeem more
than the amount of reserves in the funds, fund managers
will have to sell stocks to meet the redemptions. That
can create a spiral that leaves everybody dizzy.
Before you call your fund group demanding stepped-up
safety precautions, though, give some thought to what
you'd be asking your manager to do.
Many stock funds began de-emphasizing cash reserves
years ago, taking the position that their main job was to
pick stocks using a consistent style. Asset allocation, or
shifting money from one class of investments to another,
was deemed the customer's business.
As recently as autumn 1990, when stocks tumbled in
advance of the Gulf War, ICI data showed cash
reserves as high as 12.9 percent. They've been in a
steady decline since, eventually coming at yearend 1999
to their lowest level since they stood at 4.2 percent in
December 1972 -- just before a two-year bear market.
Today's investors measure performance closely against
a yardstick like the Standard & Poor's 500 Index,
which contains no cash at all. The cash ratio in any
good S&P index fund tends to fluctuate between zero
and about 0.2 percent or 0.3 percent. If active
managers hope to keep up in a rising market, they don't
have much room for cash reserves.
Whatever impulse might have remained among fund
managers to move in and out of cash was squelched in
1996, when the manager of the biggest stock fund of
all, Jeffrey Vinik at Fidelity Magellan, left his job after
losing a bet on bonds and money-market securities. If
Vinik wasn't safe to try this, nobody was.
Bill Gross, acclaimed manager of about $180 billion in
bonds at Pacific Investment Management Co., recently
offered another slant on stock managers' motivation:
By pumping money into the financial system when
stocks ran into trouble in 1987 and again in 1998,
Chairman Alan Greenspan of the Federal Reserve "has
demonstrated to investors that he will, when required,
lower interest rates and provide liquidity to support the
stock markets," Gross said in a recent commentary.
Gross argues that that has led stock managers to
conclude there is "a floor below which stocks cannot
fall." Though nobody knows where that floor might be,
he says, "the mere fact of a floor anywhere close to
existing levels emboldens stock investors to buy more
and more since they can make a lot but lose only a
little."
Of course the Fed has never acknowledged, and never
will, that any such floor exists. When push comes to
shove, though, will Greenspan or any other monetary
official let stocks go into the tank without trying to save
them?
And if Gross's floor does exist, stock-fund managers
would have almost a fiduciary obligation to keep their
cash reserves low. Otherwise, they'd be passing up an
offer too good to refuse.
In the "fully invested" age, fund money doesn't leave the
stock market.
It simply moves from one stock to another, one market
sector to another. This process, known as "rotation,"
can have painful effects, but never depresses the market
as a whole.
This makes many people happy, not least investors in
index funds that parallel the course of the broad market
measures.
But it's also a strong argument against bull market
complacency. If fund managers ever decide they can't
or don't want to stay fully invested any more, the
scramble to raise cash reserves could turn into a
stampede. Even the Fed might have trouble containing
it. |
