Cash Isn't King: Don't Blame Fund Managers for Staying Fully Invested

Railing at your growth fund manager for not charging into cash and bonds as tech stocks collapsed is like heckling a bond fund manager for not owning Cisco.

Since its March 10 peak last year, the tech-laden Nasdaq Composite has fallen nearly 60%, taking tech- and tech-stuffed growth funds with it. Cash would have been a warm, dry place during that monsoon and as investors saw their formerly highflying funds crater, a debate raged, centering on one question: Why don't stock fund managers cash out of stocks when they're in a freefall?

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The query is understandable, especially since some funds did raise cash levels, but market timing, which looks easy in hindsight, is essentially a loser's game. It's also not what a stock mutual fund is supposed to do. And, as we'll see, those funds that let cash levels rise didn't exactly dust the rest of the market anyway.

By and large, stock funds aren't designed to avoid losses at all costs or hop in and out of the market, trying to time its ups and downs. Rather, they're designed to own stocks and try to beat a benchmark, like the S&P 500 for instance, through savvy stock picking. That means stock funds typically keep 90% or more of their money in stocks whether times are good or bad, trying to gain more than a benchmark on the upside and lose less on the downside.

Don't get me wrong. There are plenty of growth managers who deserve scorn for their stock selections -- my (POEGX)Putnam OTC & Emerging Growth fund shares are down more than 55% over the past 12 months -- but not for holding stocks in general.

The upshot: If you thought your fund managers' overarching goal was to not lose your money, not an outlandish assumption, you're wrong. Fund managers' bonuses and jobs depend on them gaining more and losing less than their peers and an index. In the end, the person in charge of how much money you have in cash is you.

"People should have an emergency [cash] fund that covers three to six months' expenses," says Ron Roge, a financial adviser based in Bohemia, N.Y. "It's not the typical stock funds' mandate to time the market. If you thought you were paying for market timing, 99% of funds don't do that. That's a good thing because you have to get out at the right time and back in at the right time and that almost never works."

Fund investors might recall much publicized market calls that backfired. In 1997 Brandywine fund manager Foster Friess charged out of tech and into cash, missing a rally, and then moved back into tech the following year, when the sector hit a rough patch.

Before that there was Jeff Vinik, who built an eye-catching track record running the Fidelity Magellan fund from 1992 to 1996, but left soon after an ill-advised shift into bonds.

"Big returns come with big risks and market timing is a nearly impossible feat," says Russ Kinnel, director of fund analysis at Morningststar. "It's amazing how poorly brilliant managers have done at market timing -- like Vinik and Friess make terrible timing moves where they got out of stocks and into bonds. They were punished and vilified."

Vilified, indeed, Friess' shareholders vented in these pages and rightly so. When you build a portfolio, the idea is typically to keep a target percentage of your money in stocks, bonds and cash. But if your funds shift between asset classes, it's tough to gauge where your money is invested.

"Many advisers want [stock] funds to stay fully invested [in stocks] so they can control the asset allocation," says Kinnel. "I think that makes a lot of sense. If you've got fund managers making these calls in your portfolio, it will get really screwed up."

That said, cash levels have been rising. At the end of last month, the average stock fund had some 5.7% of its money in cash, according to Morningstar. That's significantly higher from a year earlier, but still well below the 6.6% cash stake the funds averaged in the same month over the past 10 years.

Cash Poor Funds' March 31 cash stakes are higher than they were a year ago, but still well below average.
2001	5.7%
2000	4.1
1999	4.6
1998	5.2
1997	6.9
1996	7.0
1995	7.5
1994	7.8
1993	9.1
1992	7.8
Sources: Investment Company Institute and Morningstar.

There are some growth funds that have raised their cash stakes well above their average peers. If we sift the growth and tech-fund bins for funds that have at least 15% of their money in cash, according to the most recent portfolio data available, we find that their heftier cash stakes haven't always led to above-average returns.

Bein' Green Here are the five funds in various growth categories with the fattest cash stakes.
Fund	Cash Position	YTD Return
Large-Cap Growth Funds
(FKDNX)Frankllin DynaTech	51%	-7.4%
(JAVLX)Janus Twenty*	25.3	-15.5
(ASGAX)Atlas Strategic Growth	25.1	-19.5
(ASPAX)Alliance Select Investor Premier	24.2	-10.2
(AMCPX)American Funds Amcap	18.5	-2.6
Avg. Large-Cap Growth fund	5.1	-13.9
Mid-Cap Growth Funds
(SEGAX)SunAmerica New Century	34.5%	-16.7%
(KGGAX)Kemper Aggressive Growth	31.3	-13.1
(OMDBX)Oppenheimer MidCap	22.1	-24.3
(RSEGX)RS Emerging Growth	20.6	-20.8
(PBHGX)PBHG Growth	18.1	-19.3
Avg. Mid-Cap Growth fund	6.7	-15.7
Small-Cap Growth Funds
(UNSAX)Waddell & Reed Advisor Small Cap	33%	-3.2%
(BRMBX)BlackRock Micro-Cap Equity	22.5	-18.5
(FUSMX)Fremont U.S. Micro-Cap	19.9	-5.7
(FMIOX)FMI Focus	19.7	-7.7
(TWNOX)American Century New Opportunities	18.9	-26.4
Avg. Small-Cap Growth fund	5.5	-12.6
Technology Funds
(DGTNX)Dresdner RCM Global Technology	23.3%	-30.1%
(ATCIX)American Century Technology	23.1	-24
(WSTCX)W&R Science & Technology	21	-14.1
(GTFQX)Firsthand Global Technology	18.4	-27
(WWWFX)Kinetics Internet	16.8	-3.9
Avg. Tech fund	8	-25.2
Sources: Morningstar and fund company Web sites.

It's natural to assume that a fat cash stake can cushion the blow of sagging stock positions, so many investors are no doubt wondering why fund managers bought stocks in a downturn. The problem with this logic is that it wasn't so easy to predict the Nasdaq's breathtaking fall.

There are always a lot of negatives in the economy and the stock market. Obviously we can see now that things snowballed into a tremendous slowdown, but it wasn't readily apparent that things would be this bad.

"If I had a strong conviction that the Nasdaq Composite would've been down this far, I could've gone more into cash or shorted some stuff, but that is highly risky. It's not what mutual funds are about," says Mark Herskovitz, portfolio manager of the Dreyfus Premier Technology Growth fund. "What a mutual fund is supposed to do is outperform its asset class over different cycles. When the Nasdaq is up I'm doing my job if I go up more and when it goes down I'm doing my job if I go down less."

He has beaten the Nasdaq and his average peer over the past three calendar years since the fund launched in 1997. The fund's 28% three-year annualized return beats 94% of its peers. The fund's 46.3% loss over the past year is steep, but less than its average peer's.

In the face of a loss like that, a flight to cash might seem like a no-brainer, but remember that it looked like a cop-out when funds like Herskovitz's took off in 1999, when the average tech fund gained 136%. A look at the numbers shows that even if you overcommitted to growth and tech investing, tossing diversification out the window, a modest cash stake would have reduced your losses without sapping much of your gains.

A portfolio with 90% of its money in the average big-cap growth fund and the rest in the average tech fund would've lost about 40% over the past 12 months, according to Morningstar. Squirreling just 10% of that money into a money market fund would've knocked about five percentage points off that loss.

If you haven't seen beta before, it measures a portfolio's volatility vs. the S&P 500. The further above 1.0 a beta is, the higher the highs and the lower the lows. As you can see, just keeping some money on the sidelines would've smoothed the road a bit.

Got Cash? Keeping 10% of your money in cash would have lightened losses a bit over the past year, without costing you much in returns

Volatility
Worst Year	(39.5%)	(35.7%)
10-Year Beta	1.15	1.04
Source: Morningstar. All data through March 31

The bottom line is that if you find yourself pointing a finger at your growth manager, asking why he or she didn't morph into a money market, you've probably taken on too much risk, and might be smart to put the same question to yourself.

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