Why Do Mutual Funds Hold Cash?

57 Pages Posted: 27 Nov 2017 Last revised: 14 Oct 2018

See all articles by Maria Chaderina

Maria Chaderina

Vienna University of Economics and Business - Department of Finance, Accounting & Statistics

Christoph Scheuch

Vienna Graduate School of Finance (VGSF); WU (Vienna University of Economics and Business)

Date Written: October 9, 2018

Abstract

We examine the role of cash in a parsimonious model of active portfolio management with performance-driven capital flows and transaction costs. We argue that redemptions following bad performance pose no dilution risk to remaining investors and what appears to be liquidity management by mutual funds is managers collecting rent. Bad performance is a negative signal about a manager and reduces the optimal fund size. Liquidations of illiquid assets to satisfy performance-driven redemptions are efficient and do not justify regulatory interventions. Accommodating redemptions with cash only, as managers with performance-sensitive compensation do, amplifies outflows and destabilizes the fund.

Keywords: Mutual Fund, Performance, Liquidity Management, SEC Rule 22e-4

JEL Classification: D86, G23

Suggested Citation

Chaderina, Maria and Scheuch, Christoph, Why Do Mutual Funds Hold Cash? (October 9, 2018). Available at SSRN: https://ssrn.com/abstract=3075091 or http://dx.doi.org/10.2139/ssrn.3075091

Maria Chaderina (Contact Author)

Vienna University of Economics and Business - Department of Finance, Accounting & Statistics ( email )

Welthandelsplatz 1
Vienna, 1020
Austria

HOME PAGE: http://https://sites.google.com/site/mariachaderina

Christoph Scheuch

Vienna Graduate School of Finance (VGSF)

Welthandelsplatz 1
Vienna, A-1020
Austria

HOME PAGE: http://ckscheuch.github.io

WU (Vienna University of Economics and Business) ( email )

Welthandelsplatz 1
Vienna, A-1020
Austria

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