(08/18/14) Cash-Heavy Funds

With equity valuations on the high side, interest rates on the low side, and volatility increasing in both the stock and bond markets, an increasing number of investors have asked us to identify excellent funds with significant, tactical cash positions, notes Mark Salzinger, editor of The No-Load Fund Investor.

If stocks and bonds fall from current levels, the shareholders of such funds should lose less than market benchmarks, while the managers may be able to take advantage of lower securities prices to snap up bargains.

Of the 65 funds included in Best Buys in June, not even one had a cash position of at least 15%. In fact, cash accounted for at least 10% of assets in only three: Fidelity Low-Priced Stock (FLPSX), with 14.9% in cash; Metropolitan West Unconstrained Bond (MWCRX), with 13.3% in cash; and Fidelity New Millennium (FMILX), with 11.0% in cash.

Low-Priced Stock uses a value investing style and targets its new purchases on stocks selling at less than $35 a share. Though the fund is not specifically small- or mid-cap, this pricing preference leads the managers to favor such stocks.

Joel Tillinghast, the lead manager of the fund, wrote in his fund commentary for the second quarter that he and the fund’s co-managers began increasing the cash position amid the sizable run-up in the Russell 2000 Index beginning last year, deeming many stock valuations to be too high.

The managers of Metropolitan West Unconstrained Bond can invest in various kinds of debt securities while adjusting the fund’s duration with derivative strategies.

As they have been expecting interest rates to increase, they have been keeping the fund’s duration to a minimum—recently only 1.13 years (just slightly longer than that of a one-year Treasury bill). Cash and equivalents (essentially duration of zero) help them do that.

Because of its strong performance last year, when it gained 37.2%, Fidelity New Millennium has attracted new money from investors this year at a brisk pace.

This growth fund’s manager, John Roth, wrote in his most recent fund commentary that he was being cautious and selective in deploying the inflows, as attractive entry points have become increasingly difficult to find amid stretched valuations.

This appears to be true despite the fact that New Millennium has traditionally been more of a growth than a value offering, without very much emphasis on finding stocks with especially attractive valuations.

Roth groups the fund’s holdings among three broad categories: emerging growth stocks, long-term compounders (more established, steady, moderately growing companies), and cyclical opportunities/special situations.