Mutual Fund Cash Levels Jump

The latest monthly statistics from the Investment Company Institute are out, and they show that portfolio managers in June raised a significant amount of cash during the sell-off.

While the S&P 500 slumped more than 5% during the month, and fund managers were hit with net redemptions, they also raised more of a cushion of liquid assets in case even more redemptions came in down the road. They moved from having 3.5% of assets in cash in May to 3.8% in June.

Granted, that is still pathetically small in relation to their historical range - in fact, it's creeping along the very bottom, which usually coincides with periods of excessive optimism. There are structural reasons for funds to hold little cash now (extremely low interest rates don't give much return on cash balances, fund charters prevent "market timing", etc.), but still.

While the level of cash assets is abnormally low, they did at least jump more than 8% from where they were in May, which is one of the largest one-month jumps in cash balances we've seen in the past decade.

Historically, whenever mutual fund cash increased by more than 8% in one month while the S&P suffered a loss of more than -5% (such as we saw in June), then the following month is a also poor one for the S&P 500. It has rallied only 40% of the time and sported an average return of -1.8%.

But we know that didn't happen. During July, we're on track for the S&P to gain more than 5%, unless we have a very, very bad day today. So we bucked the historical trend of seeing follow-through weakness after fund managers so dramatically raised their cash levels.

Since 1950, we've seen something similar 10 times. The table below shows how the S&P 500 fared going forward whenever fund managers raised their cash level by at least 8% one month (June), then the S&P rose more than 5% the following month (July).

Date	1 Month Later	3 Months Later	6 Months Later	1 Year Later
Jun-55	6.1%	6.4%	10.9%	14.5%
Apr-68	1.3%	0.3%	6.1%	6.4%
Jul-70	4.5%	6.7%	22.8%	22.5%
Dec-71	1.8%	5.0%	5.0%	15.6%
Mar-79	0.2%	1.3%	7.6%	0.5%
May-85	1.2%	-0.5%	6.7%	30.5%
Nov-85	4.5%	12.2%	22.4%	23.3%
May-86	1.4%	2.3%	0.8%	17.3%
Sep-98	8.0%	20.9%	26.5%	26.1%
Apr-03	5.1%	8.0%	14.6%	20.8%

Median	3.1%	5.7%	9.2%	19.0%

Remarkably, there was only one loss in the entire table, a miniscule -0.5% dip three months after the occurrence in May 1985. Other than that, the S&P showed positive results across every time frame in all 10 instances.

Over the next year (using closing monthly prices only) the average maximum drawdown (i.e. loss) was -1.3%. The average maximum gain was +22.4%. That's quite a spread between risk/reward.

If we relax the parameters a bit to get more occurrences, and only look for a 5% jump in mutual fund cash the month prior to the S&P increasing 5%, then over the next year the S&P still showed a positive return 21 out of 23 times, with a median return of +16.3%, drawdown of -3.4% and maximum gain of +20.1%.

It seems that the fact that the market has bucked the usual downside follow-through from a sudden scramble for cash by portfolio managers may be a positive influence in our current case.