Funds' Low Cash Reserves Portend Higher Volatility

Mutual fund cash positions dipped to their lowest point in nearly 30 years at the end of 1999, and it appears that many managers used their cash to go on a tech-stock binge. That may have boosted returns last year, but it could leave them -- and you -- in a tight spot this year.

The percentage of cash in stock mutual funds dropped steadily in last year's fourth quarter to 4.15% at year-end from nearly 5% at Sept. 30 -- the lowest level since the early 1970s, according to Charles Biderman, publisher of the Liquidity Trim Tabs and Mutual Fund Trim Tabs newsletters. Biderman and other industry experts say much of that cash went into precious few tech stocks. That could set investors up for a hard landing if tech stocks come back to Earth.

Although a 0.85% drop in cash might seem modest, it equals roughly $20 billion, according to Biderman. And in a year when managers who didn't own tech didn't perform, it looks like a fair amount of that money gushed into the high-octane sector. Around half the 1999 returns of most tech indices and funds came in the fourth quarter.

"When $20 billion goes into the same 20 or 30 stocks, what do you think happens?" asks Biderman.

Tech: A Late Boomer Fourth-quarter flows into tech stocks might've helped make 1999 a stupendous year
Index	1999 return	4Q return
Nasdaq Composite	85.6%	48.2%
Merrill Lynch 100 Technology	133	62.9
Inter@ctive Week Internet Index	168	77.4
Lipper Technology Funds	134.8	63.8
Lipper Large-Cap Growth Funds	38.1	26.6
Wilshire Large-Cap Growth Index	35.5	24.4
Source: Baseline, Lipper, Wilshire.

"We saw a lot of funds take big tech positions in small-, mid- and large-cap funds running up the tech ladder in the last half of last year. The old rules used to be "Buy low and sell high." Last year, some managers followed new rules -- "Buy high and sell higher," says Phil Edwards, a managing director with Standard & Poor's fund-rating service.

"For all of 1999, it was a heavily concentrated market. If you weren't playing in tech stocks, IPOs and Net stocks, you weren't doing well," adds Tom Stevens, chief investment officer at Wilshire Asset Management in Santa Monica, Calif.

The stunning flows into tech-heavy Janus funds probably contributed to the fourth quarter's tech blowout. The growth-fund specialist started 1999 with $79 billion, then its stock funds took in a mind-blowing $153.9 billion through year-end, according to Boston fund-watcher Financial Research.

A whopping $35.7 billion of that total went into Janus stock funds in the fourth quarter -- almost 25 cents of every dollar invested in stock funds. Most of the firm's funds follow a similar growth style, which leads them to many of the same stocks. (Janus prospectuses disclose the funds' tendency to overlap.)

A portfolio of Janus' U.S. stock funds would have eight technology or media stocks in its top 10 holdings, according to the most recent data from Morningstar. The top holding? Networker Cisco (CSCO), which is in eight of 11 Janus U.S. stock funds. The stock rose 56% in the fourth quarter and 131% for the year.

Further feeding the flow of money to tech stocks were S&P 500 index funds. At year-end, the tech allocation of the market-cap-weighted index had grown to more than 25%, up from 16% at the end of 1998. Microsoft (MSFT) is the top holding in the $100.4 billion Vanguard (VFINX)500 Index fund, which took in more than $12 billion last year. Six of the fund's top 10 holdings are technology or telecommunications companies.

If funds and, perhaps, individual investors are betting on a thin band of stocks, what are the consequences in a downturn?

"This trend is building, and it never ends pretty," says Biderman.

Cash acts as a cushion for most funds in two ways: It allows managers to pick up shares of companies they like at cheap prices during a sudden downturn or selloff. And it allows fund firms to meet redemptions without having to sell stocks in a downturn, which can shred returns. Right now, about half of fund firms are in net redemptions. That means more money is leaving than coming in.

"With less cash on the sidelines, there's less money to buoy up the market when it comes under pressure," says Wilshire's Stevens.

Biderman and others also say there is anecdotal evidence that margin debt among individual investors, particularly online investors, is on the rise. If more individuals are buying tech stocks on margin, a falling market could lead to painful margin calls as well.

The situation isn't reason to panic, as long as you're aware of the risks you're taking either with a fund or buying stocks on your own. Biderman advises investors to simply be aware that when the music stops for tech stocks, the market's current exposure may mean fewer chairs to go around.

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