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Cash levels of funds

On Monday, I noted that the cash level of our currently recommended Sector Rotation fund had soared during the 4th quarter of 2008. As this Morningstar article reports, several currently recommended Upgrading funds have also been beneficiaries of large cash holdings in recent months.

Some financial advisors don't like using funds that let their cash levels rise when conditions seem inopportune to the manager. That's understandable, as the advisor is trying to allocate investment capital between asset classes, and doesn't want to be left wondering if his 60% stock allocation is truly only 50% because of cash sitting around in his stock funds (an issue we discussed a bit recently in the comments of this post).

However, as Upgraders, we're not particularly concerned if a given fund has a high cash holding or not. That's because the performance impact of holding that cash is going to be reflected in the fund's momentum score. If the manager was just lucky to be holding cash when the market downturn occurred, that will likely be revealed when the market eventually rises and the fund lags due to the cash holding. But if raising cash was a result of skillful management, we benefit by avoiding damage as the market declines, and then potentially benefit again as that cash is intelligently deployed before the market rises again (as funds holding cash will lag in a rising market).

Upgraders can relax and simply focus on the MOM scores - the manager's cash management or lack of will show up there.

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