Set My Fund Manager Free, Readers Say

Fund managers should have more leeway to let their cash stakes rise a bit--or a lot. That's the feeling of the overwhelming majority of readers who responded to a recent Fund Spy column. That column floated the idea that fund shareholders might be better off if managers, who often are required--formally or informally--to keep their portfolios almost fully invested at all times, were granted more flexibility.

I invited readers to send in their opinions, and it was gratifying to receive so many responses. It seems that investors relished the opportunity to share their thoughts on a matter of importance which so often seems out of their control. Also noteworthy was the thoughtful, carefully written, and well-argued nature of the responses.

Of course, the messages were not identical. Some readers wanted all managers to have leeway and take full advantage of it, while others wanted to limit that freedom to a select group of managers, or to a fairly small portion of the fund's portfolio. And a minority of readers answered in the negative: No cash stakes in their funds.

The Overall Results
It was something of a surprise that readers voted so strongly in favor of reducing the shackles on their managers. Over the years we have typically heard the opposite sentiment. When markets are rallying, shareholders want managers to invest, not sit on the sidelines.

It's good to keep in mind, therefore, that this is not a scientific poll; there was no attempt to get a cross-section of respondents. As with a consumer-products 800 number, it's possible that the bulk of the people who choose to respond are those with a complaint. And in the current environment, those with a bone to pick are more likely to be those whose managers have kept all their funds' money in the market as it kept falling and falling. The responses might have gone in the other direction had this question been raised in 2006--or the late 1990s.

Digging into the Details
We don't know that for sure, though. And it's obvious from their answers that Morningstar.com readers have given much thought to this issue--they weren't merely responding out of pique at their funds' losses. No e-mails consisted of a simple yes or no. Readers included explanations of their positions, supporting statements, and sometimes, suggestions for a better way.

One of the most common responses was that investors could, and did, own a variety of funds. Readers said they expected some of those funds to stay fully invested at all times, and some used index funds for that purpose. But with that core in place, they are willing to allow the managers of their other funds more discretion.

Many respondents, in fact, demonstrated humility. We hire the portfolio managers because they're smarter than we are, or have better information and insights, these readers said. So if they feel it's best to let cash pile up because opportunities are few, or they foresee a sharp market decline, by all means let them do so.

That still left the question of how much cash to allow. In that area there was no agreement. Some readers said they wanted to allow some flexibility but considered 10% a reasonable upper limit for a cash stake. Others said a manager who feared a market decline should be able--even expected--to stash up to 50% in cash, or even more.

Those readers willing to allow the most leeway often cited with approval specific funds that are among the rare examples that do have the option of holding higher cash stakes. These readers already own these funds, they say, because they trust the managers to use their freedom wisely. Ken Heebner's CGM funds and First Eagle's funds were mentioned by several readers as those with managers who have used their flexible asset-allocation mandates well for shareholders over the long term.  Fairholme Fund (FAIRX) and  Mutual Discovery (TEDIX), which had a giant cash stake in the latter part of 2008, also received commendation in this regard.

A particular surprise was that several financial advisors, a group I had assumed would be most adamant about having fully invested portfolios, were willing to allow managers a great deal of flexibility if such managers had a long-term record of success with that approach.

Not everyone, of course, agreed on the benefits of flexibility. Some readers said that allocating money to cash was their job, or their advisor's, and should not be left to the discretion of the fund manager.

Other Issues
Many readers brought up other points of interest. One concerned disclosure: A significant amount of respondents said they don't have a preference for whether a fund should or should not require full investment as long as that policy is clearly spelled out in the prospectus and other fund literature and is adhered to. Some readers accurately noted that most prospectuses do allow managers to go to cash in extreme circumstances--prospectus language tends to be very broad in most respects in order to provide legal cover--but that in practice many funds don't do that under any circumstances, with detrimental consequences during this crash.

In short, many readers felt the issue was not really whether funds should be allowed to go to cash, but that there should be clear disclosure of a policy--beyond the boilerplate language in a prospectus--and that policy should be strictly and consistently applied. Of course, investors aren't off the hook; they must make sure to read and understand the fund's policy if it is indeed clearly spelled out.

Another interesting point was brought up by one reader, who suggested that funds could come in two versions--one fully invested, one with more flexibility. That might seem hard to pull off, but it does have precedent. A while back,  UMB Scout International  offered itself in two varieties, with one typically having about 15% in cash and the other fully invested. Meanwhile, some international-bond funds currently come in two versions--hedged and unhedged.

Conclusion
It's good to remember, as one reader pointed out, that funds with specific mandates mentioned in their names, such as "large cap," are required by the SEC to keep at least 80% of assets invested according to that mandate. For such a fund, holding more than 20% of assets in cash would likely be allowed only for very brief periods. (Of course, that still allows a significant amount of leeway, for having a cash stake anywhere close to 20% would be substantially higher than the norm for most funds.)

In conclusion, let me thank the many readers who responded, for I have not been able to reply to all. On this complex question there is no single right answer, and getting a wide variety of opinions from knowledgeable readers, and then being able to share them even more widely, hopefully is helpful to all.