In July 2024, equity mutual fund (MF) schemes saw a significant rise in cash reserves due to market volatility following the Union Budget and concerns over high valuations. The cash held by the top 26 fund houses jumped to nearly ₹80,000 crore by the end of July, marking a 27% increase from ₹62,700 crore at the end of June, as reported by Motilal Oswal. This brought the cash proportion in these schemes to 5.4%, a 15-month high, up from 4.6% in June.
Despite a general mandate to remain fully invested, MF managers have the flexibility to hold cash during uncertain times or when valuations are too high. Concerns about valuations, particularly in the midcap and smallcap segments, have persisted for almost a year. Yet, equity MF schemes have consistently attracted strong inflows, supporting a prolonged market rally.
In July, the equity market performed well despite a negative surprise in the Union Budget, which increased the capital gains tax on equities. The Nifty 50 and S&P BSE Sensex recorded gains of 3.9% and 3.4%, respectively, for the month. As of mid-August, the Nifty 50 was trading at a 12-month forward price-to-earnings (P/E) ratio of 20.2x, higher than its five-year average of 19.3x. The Nifty Midcap 100 and Nifty Smallcap 100 were also trading at elevated P/E ratios, indicating potentially high valuations.
Tata MF noted that the Nifty 50 is trading at an 89% premium to the MSCI Emerging Markets Index, which is above its historical average of 50%. Global market volatility in August, fueled by slowdown concerns in the US, has added to fund managers’ worries. Earlier in the month, markets experienced their worst single-day decline since June 4.
SBI MF expressed concerns about the market’s rich valuations and the potential for reduced speculative activity. Their proprietary sentiment index, which typically moves inversely to expected returns, suggests caution.
The Motilal Oswal report highlighted that Parag Parikh Financial Advisory Services (PPFAS) MF had the highest cash holding at 16.1%, followed by Quant MF at 14%. Other fund houses, including ICICI Prudential MF, Franklin Templeton MF, Sundaram MF, and Motilal Oswal MF, also increased their cash reserves. Conversely, SBI MF and Aditya Birla Sun Life MF saw a drop in their cash holdings.
Experts believe that the strong inflows from new fund offerings (NFOs) in July likely contributed to the higher cash levels, as fund managers tend to deploy these funds gradually, especially when collections are large.
Equity MF schemes stockpile (FAQs)
Why did equity mutual funds increase their cash holdings in July 2024?
Equity mutual funds increased their cash holdings due to market volatility following the Union Budget, concerns about elevated valuations, and significant inflows from new fund offerings (NFOs).
What is the typical mandate for cash levels in equity mutual funds?
While the typical mandate is for mutual funds to remain fully invested, fund managers have the flexibility to hold cash during periods of market uncertainty or when valuations are high.
How does high cash holding impact a mutual fund’s performance?
High cash holdings can provide a cushion during market downturns, but they may also limit the fund’s ability to fully participate in market gains during bullish phases.
Why are mutual funds concerned about valuations in midcap and smallcap stocks?
Valuations in midcap and smallcap stocks have been high for nearly a year, making them more susceptible to price corrections, which is why mutual funds are cautious.
What caused the market volatility after the Union Budget in July 2024?
The volatility was mainly triggered by the unexpected increase in capital gains tax on equities announced in the Union Budget, which surprised investors.
How do mutual funds decide when to deploy cash reserves?
Fund managers typically deploy cash reserves gradually, especially after large collections from NFOs, and based on their outlook for market conditions and valuations.
What are the risks of holding too much cash in an equity mutual fund?
Holding too much cash can reduce a fund’s returns during market rallies, as the cash remains uninvested and does not generate returns.
How do new fund offerings (NFOs) affect a mutual fund’s cash holdings?
NFOs can lead to higher cash holdings as fund managers collect large sums of money, which they deploy over time rather than immediately.
What is the significance of the P/E ratio in assessing market valuations?
The P/E (price-to-earnings) ratio is a key metric used to assess whether a market or stock is overvalued or undervalued compared to historical averages.
How did global market conditions in August 2024 affect Indian mutual funds?
Global market volatility in August, driven by concerns of a slowdown in the US, added to the cautious sentiment among Indian mutual fund managers, leading them to maintain higher cash levels.