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Why Do Mutual Funds Hold Cash?

55 Pages Posted: 27 Nov 2017  

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: November 21, 2017

Abstract

We argue that mutual funds might hold liquid assets to collect rents. We propose a parsimonious model of active portfolio management that incorporates trading costs and liquidity management. Following bad performance, managers compensated on total assets under management optimally reduce illiquid and liquid holdings to maximize expected returns. Managers compensated on past performance, on the other hand, accommodate redemptions by depleting liquid assets first. This strategy, however, exaggerates outflows and destabilizes the fund due to lower expected returns. Moreover, using cash for rent collection is preferred to higher management fees as it makes mutual funds less prone to redemption shocks. Overall, we challenge the interpretation of liquid holdings as conclusive evidence for the degree of liquidity transformation that mutual funds provide.

Keywords: Mutual Fund, Performance, Liquidity Management

JEL Classification: D86, G23

Suggested Citation

Chaderina, Maria and Scheuch, Christoph, Why Do Mutual Funds Hold Cash? (November 21, 2017). 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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