These Funds Have Plenty of Cash at the Ready

For musically inclined investors, the Dow's new all-time high last week may have brought one of two songs to mind. Those who are bullish on the market's future direction may have heard, "Happy Days Are Here Again" buzzing through their minds. But for those who see the recent runup in equities--which has produced a 9% gain in the S&P 500 so far in 2013--as a sign of an imminent downturn, "Stormy Weather" may be a better choice. 

Whichever tune you find yourself humming these days (and other choices are perfectly acceptable), it can be instructive to know how invested your actively managed equity funds are in the market. (We focus on actively managed funds for this discussion because index funds tend to be fully invested in their quest to track a given index as closely as possible.) This means paying attention to the fund's allocation to cash. If an actively managed fund maintains just a percentage point or two of assets in cash, it may be a sign that the manager likes what he or she sees in terms of opportunities, or at least is content to stay mostly invested. Some fund mandates may also restrict a manager from holding a lot of cash. The average actively managed equity fund currently holds about 2.2% of assets in cash.

A much larger cash allocation--say, 10% or more--may indicate the manager believes the market is overbought, or perhaps the manager doesn't see many attractive opportunities in the fund's specific stomping ground. Granted, a bigger cash stake may not be unusual, or particularly germane to the market today. It could be temporary, such as a recent sale's proceeds that will be deployed again soon. Or maybe the manager has a habit of keeping a certain percentage in cash in order to pounce on specific opportunities that can happen in any kind of market. But if you've noticed your fund's cash stake building over time, it might be worth checking the fund's manager letters or quarterly updates for clues about a change in management's sentiment.

Morningstar's price/fair value ratio for the broad stock market stood at 1.03 as of the March 11 market close, suggesting that stocks overall are just slightly overvalued right now. But a closer look at the sectors finds more variance. For example, consumer defensive names (with a price/fair value of 1.09) look somewhat overvalued to Morningstar analysts right now, so a like-minded fund manager who tends to favor such stocks might have reason to keep more assets in cash than a fund manager who prefers communications services stocks (with a price/fair value of 0.89), which look somewhat undervalued to us.

For investors looking for actively managed funds that have been keeping some powder dry, and therefore could be poised to take advantage of any market correction that may occur, we offer the following screen of quality equity funds with allocations to cash of at least 10%. Using the  Premium Fund Screener for our search, we stuck with noninstitutional funds that have earned a Morningstar Analyst Rating of Bronze or better, are open to new investors, and have at least $500 million in assets. We also screened out funds that charge a load, though Morningstar Premium Members who don't mind paying one can remove this component.  Premium Members can see all the names on the list by clicking  here. Below are two of these names.

 Delafield Fund     
Category: Mid-Cap Value | Assets in Cash: 20.1%   
Despite holding one fifth of assets in cash for much of last year, this mid-cap value fund still delivered a 20.2% return in 2012, landing it in the top 13th percentile for its category. (2013 hasn't been as kind so far, with the fund currently residing in the bottom decile for the year to date.) Morningstar fund analyst Kevin McDevitt says that despite the fund's volatility, its experienced management team has shown a knack for preserving capital while seeking out stocks that appear cheap as a result of failed acquisitions, misguided strategies, and management upheaval. The fund's large cash cushion, which currently is at the high end of its historical range, allows Delafield's managers to take advantage of buying opportunities as they emerge, McDevitt says. Industrials (38%), basic materials (26%), and technology (19%) stocks dominate the portfolio.

 Weitz Partners Value (WPVLX)   
Category: Large Blend | Assets in Cash: 23.8%    
This contrarian fund's management team takes an all-cap approach, seeking out buying opportunities wherever they find them. They also aren't afraid to let the fund's cash stake build up if they don't see opportunities in the market. When equity valuations rise--as they have recently--management would rather let cash build than compromise their buy discipline, McDevitt says, and at close to 24%, the fund's cash stake is at its highest level in seven years. Although cash will hold down returns if the market rallies further, the managers have made good use of their cash stake in the past. The fund has been a strong overall performer, with trailing one-, three-, and five-year returns, all in the top decile for its category as of March 11.

Portfolio data as of Dec. 31, 2012.