Is Your Mutual Fund Holding Cash Equivalents?

To protect against too much aggregate risk, most mutual funds do hold some degree of cash equivalents. This category of investments, called cash and cash equivalents (CCE) formally, describes short-term investments that can immediately be converted into money. Examples include short-term government bonds and money market funds. In particular, CCE investments mature in three months or less. Though there is little room for growth with such a fast turnaround, these securities are valuable for their ability to protect against risk.

Converting to Cash

The main reason a mutual fund must hold CCEs is that it may actually need to convert them to cash to pay out investors. This mostly occurs in a recession or market crash. Many investors may begin calling in their shares of a fund, looking to pull out of the market. If the fund has fallen below the principal investment sum of the investors, these CCEs can be liquidated quickly in order to meet the demand for payoff. They very rarely drop below their initial investment level, whereas other investments may be valued too low to liquidate at the given time. 

Holding Distributions

Mutual funds are subject to holding distribution rules according to the classification they fall under. Money market funds, for example, have very explicit holdings rules that require them to hold at least 10 percent of all holdings in CCEs that can be converted within one day. Mutual funds under different classes may not hold this high level, but all funds will carry some CCEs simply to protect themselves in the case they need to repay investors quickly. An additional amount of holdings must be in securities that can be converted to cash within a narrow window up to a week or month. 

Protection for Investors

Mutual funds hold CCEs to protect both investors and themselves. On the one hand, this is for the fund's protection from having to issue an IOU or declare bankruptcy if the fund loses money in a rapid downturn of the market. On the other hand, it is in the investor's best interest to keep the fund alive in this case, so this is not an entirely selfish act on the fund's behalf. Since CCEs have a low level of return on investment, though, a fund should never over-invest in this liquid market. Maintaining a level of protection is the goal, and once this goal is met, the fund should move on to higher-risk investments. 

Does your Mutual Fund Hold Cash Equivalents?

You should want your mutual fund to hold some CCEs. This is the biggest assurance you can receive that you will be able to get out of the fund when you want to get out of the fund. When your fund issues a prospectus, review the information to check for CCE investments. It is not required that your fund disclose this information, but the information may be apparent on the simple document. You can also ask your broker or manager about the percentage of the fund invested specifically in CCEs. The figure should range from 3 percent to 10 percent depending on your appetite for risk. 

blog comments powered by Disqus