Should stock-fund managers shift to cash?

Those who did suffered smaller losses last year. Yet few welcome that strategy.

If you own a stock mutual fund, how much of the fund's money should be in cash?

As little as possible is the traditional answer. But that was before the great stock market crash of 2008.

Consider First Eagle Overseas fund. It lost only 21 percent last year, making it one of the Top 10 international funds while holding more than 10 percent in cash, wrote senior Morningstar analyst Gregg Wolper in a recent article. Another top performer: Third Avenue International Value, which had about 15 percent of its assets in cash in mid-2008. On the domestic front, Tweedy, Browne Value and the Yachtman Fund also had more cash than average and they, too, were among the leaders in 2008.

These results have at least some investors rethinking what they want from their fund managers. In his admittedly unscientific survey of readers, Mr. Wolper found that most people wanted to give managers more leeway to "go to cash," he says.

When stock prices were steadily rising, it would have been hard to find investors who didn't want their mutual funds to be "fully invested." In other words, these funds were expected to have almost no cash, perhaps 2 or 3 percent of assets, in their portfolios.

Stock funds, in particular, were expected to have at least 95 percent of their money in stocks. After all, if you were putting money in one of these funds, you wanted the manager to buy stocks, not sit on the sidelines with a bunch of cash. "When somebody buys a fund, that's what they expect," says Brian Lewbart, spokesman for T. Rowe Price in Baltimore.

A small amount of cash is considered acceptable, as it allows the manager to meet redemptions without having to sell too many stocks and to take advantage of buying opportunities. If investors do want more cash in their own portfolios, the thinking goes, they can add to their money market funds. Or, if they're really concerned about safety, they can park some money in bank certificates of deposit.

Even in a down market, many financial advisers would probably prefer that funds keep their cash levels low, Wolper notes, because they get paid to make the asset allocation calls. They want to decide how much cash, as well as stock and bond funds, should be in each client's portfolio.

It isn't easy finding out how much cash a fund holds. Most stock fund prospectuses are rather vague on this point, with phrases such as "the fund will normally invest at least 80 percent of net assets in common stocks." The holdings sections of most annual and semiannual reports will show the amount of cash in a fund at the end of the last reporting period. While that information may be a few months old by the time the report lands in your mailbox, it does give a general idea of the fund's strategy when it comes to cash. Some companies also provide more recent information on their website, or give it to their telephone representatives.

"It's important for fund companies to make it clear what their policies are," Wolper says.

At Fidelity Investments in Boston, for example, equity funds typically maintain cash positions of less than 1 percent, a company spokesman says. However, cash positions can fluctuate between 2 and 10 percent for diversified funds, and may hit the higher end of that range for the firm's industry-specific "select" portfolios.

If the current volatility in the stock market continues for any length of time, more funds may begin to maintain higher cash levels, and not necessarily because they think that's the best strategy for them.

"The public will ultimately determine what the mutual funds do about cash levels," says Rusty Vanneman, director of research at E*Trade Capital Management. "The market has had a really tough time of it for the past year and the funds' long-term returns have suffered as well."

"I think shareholders will prefer those funds that have higher cash levels," Mr. Vanneman adds. "It will either be through direct preference because they know the cash is there, or indirect preference because they're chasing mutual funds with better relative performance because they had higher cash levels. My guess is that we will see the mutual fund industry in the aggregate have higher cash levels for their funds, whether it's a conscious decision by the industry or not."