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Home>Research & Insights>Investment Insights>A Large Cash Stake Doesn't Necessarily Make for a Low-Risk Fund

A Large Cash Stake Doesn't Necessarily Make for a Low-Risk Fund

Managers who stockpile cash often take risks in other areas.

Dan Culloton, 08/01/2017

A big cash stake can offer a false sense of security.

One of the potential benefits of an actively managed fund that often keeps a big portion of its portfolio in cash is lower volatility in times of market stress. Of course, investors in these funds typically sacrifice some of the upside in rising markets because they're not fully invested.

They can console themselves, however, with the belief that they won't have as deep of a hole to climb out of after the coast clears. Plus, their managers may have been able put some of that cash to work opportunistically during the downturn.

Keeping a lot of powder dry, though, does not mean a fund is completely out of harm's way. Managers who tend to hold double-digit liquidity levels are often maverick investors who are willing to let their convictions rather than benchmarks or peer group averages drive position sizes and sector allocations. It's not unusual to see significant stock, sector, and geographic concentration in these funds, which can offset some risk-damping effects of holding cash. Here are four funds that have a lot of cash ballast but still court significant risks in their portfolios.

Longleaf Partners Small-Cap LLSCX had nearly 28% of its assets in cash as of June 30, 2017, which is not unusual for portfolios from this uncompromising value shop. It's run by benchmark-agnostic, value-oriented stock-pickers who are not averse to stockpiling cash if valuations are unattractive. The fund remains extremely concentrated, though, with fewer than 20 stocks, 53% of assets in its top 10 picks, and double-digit helpings of consumer discretionary and technology stocks.

These managers aren't afraid to look out of step with their peers and relevant benchmarks. As a result, it's likely this idiosyncratic portfolio will take a hit at one time or another, regardless of the size of its cash stake. Indeed, the fund lost 6.0% in 2015 while it's prospectus benchmark, the Russell 2000 Index, fell 4.4%; errant energy and consumer discretionary picks hurt that year. The fund gets a Morningstar Analyst Rating of Silver because its high-conviction approach should deliver over the long term, but its often-massive cash stake can't be counted on to temper its boldness. 

Gold-rated FMI Common Stock FMIMX  has more than 18% of its assets in cash, higher than average for this fund; but it's not as concentrated as Longleaf Partners Small-Cap, with a comparatively diversified 36 holdings and about a third of its assets in its top 10. The fund has more than twice the Russell Midcap Index's helping of industrial stocks, though. It also has no energy exposure and negligible healthcare holdings. Bottom-up stock-picking drives these sector leanings and should work out for this patient, value-oriented fund in the long run, as it has in the past. Bumps are still possible, though. It, too, had a rough 2015, shedding 6.8% (though many of the stocks that hurt it that year have helped it since).   

Bronze-rated Virtus KAR Small-Cap Growth PXSGX has more than 12% cash, but it also has nearly half its assets in its top 10 holdings and fewer than 25 stocks in the portfolio overall. More than a fifth of those assets are in technology stocks, so when that sector takes a turn for the worse, this fund could, too, even with its large cash buffer. Indeed, when tech stocks dove on Friday, July 28, this fund, which has ranked ahead of 95% of its small-growth Morningstar Category peers so far for the year to date, dropped about as much as its average peer.

Silver-rated Invesco Asia Pacific Growth ASIAX has more than 11% assets in cash, but this fund roams riskier turf and is no cautious index-hugger. Its category, Pacific/Asia ex-Japan Stock, is essentially an emerging-markets group; its opportunity set comprises China and India.

This fund is willing to depart from the pack and benchmark, though, by heavily overweighting smaller markets, such as Indonesia, the Philippines, and Thailand, and downplaying or shunning altogether larger Asian developing markets, such as China and India. That, plus the managers' focus on sustainable earnings growth, management quality, and valuations, can take some, but not all, of the edge off this portfolio. The fund lost less than its prospectus benchmark and peers in 2008 and 2015, for instance, but that still meant dropping more than 50% and 7%, respectively.

Managers who are willing to hold a measure of cash when opportunities are scarce can achieve competitive risk-adjusted returns over the long term, but they take their share of risks, too. 

Dan Culloton is an associate director of fund analysis for Morningstar and editor of Morningstar's Vanguard Fund Family Report, a monthly newsletter that offers independent, no-holds-barred guidance on the pros and cons of this dominant fund family. Click here for a free issue of the Vanguard Fund Family Report.

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