Cash Holdings and Mutual Fund Performance
Review of Finance, Forthcoming
52 Pages Posted: 2 Dec 2009 Last revised: 8 Jul 2013
Date Written: July 8, 2013
Cash holdings of equity mutual funds impose a drag on fund performance but also allow managers to make quick investments in attractive stocks and satisfy outflows without costly fire sales. This paper shows that actively managed equity funds with high excess cash -- that is, with cash holdings in excess of the level predicted by fund attributes -- outperform their low excess cash peers by over 2% per year. Managers carrying high excess cash compensate for the low return on cash by making superior stock selection decisions, whereas less capable managers find excess cash costly and remain more fully invested in equities. Managers of high excess cash funds also proficiently satisfy fund outflows and control fund transaction costs, while low excess cash funds lack flexibility to cover outflows and can suffer from costly fire sales. The empirical evidence suggests that managers carrying excess cash benefit from the flexibility it provides despite the costs of holding cash.
Keywords: Mutual fund, cash holdings, fund liquidity, fire sales, stock selection skills
JEL Classification: G12
Suggested Citation: Suggested Citation