What should investors do if their mutual fund makes cash calls?

Cash calls by MF can be beneficial in the current market conditions, but they can also be risky. Continue reading to learn what investors should do if their mutual funds are sitting on cash.

If you have ever looked at the portfolio of a mutual fund in which you have invested, you may have noticed that a specific percentage of the assets are allocated to cash or cash equivalents. This is particularly noticeable in equity funds, where cash holdings range from 5 per cent to 7 per cent on average. This is frequently done to properly handle redemptions without damaging the overall portfolio.

However, if the fund has less cash, excessive redemptions will force managers to sell assets from the portfolio to meet the redemptions. As a result, keeping a reasonable quantity of cash on hand is ideal. However, there are a few mutual funds that may have more cash on hand at times. There are two primary reasons for keeping extra cash on hand. Receiving a high inflow (often in the case of a New Fund Offer), but existing opportunities are less appealing is one rationale. The other is a straight cash call to cushion market volatility.

Few mutual funds have taken cash calls in the current market environment. As a result, in these unpredictable periods, such funds tend to do well, and the majority of those with a recency bias end up investing in them. When the market reverses and rises to new highs, the same funds fail to capitalise on the rally.

Rather than focusing just on results, it is critical to examine mutual funds holistically. When choosing a mutual fund, consider the consistency of the fund's returns, the risk taken by the fund, its portfolio, its sector allocation, and so on. Although cash calls are not a red flag, they are a double-edged sword that, if used incorrectly, may severely reduce fund returns.

Axis Mutual Fund is an example of a mutual fund company that accepts cash calls. So, nothing better than comparing the performance of Axis Bluechip Fund and Axis Mid-Cap Fund to their respective categories and indices.

The preceding graph clearly shows that the cash holdings of these funds increased prior to August 2020. As a result, when cash holdings were high, we would examine the performance of these funds.

The above table contains two scenarios: a) when markets were positive and b) when markets were negative. As can be seen, when the markets were up (as in the case of the Axis Bluechip Fund), the fund not only underperformed the index but also its category. On the other hand, when markets were negative (as in the case of the Axis Mid-Cap Fund) and cash holdings were larger, the fund outperformed not just the index, but also its category.