The Incredible Shrinking Mutual Fund Cash

(MoneyWatch)  It hasn't been that long that I heard some TV investment guy building a bull case on "cash on the sidelines," that investors had plenty of cash to put to work. But it turns out that mutual fund managers have burned through a ton of cash, and now are carrying a very thin cushion -- just 3.6 percent of their funds' assets.

Is this good news or bad news? I didn't dig this one up, it comes from Bloomberg, and they are cautious:

The last time stock managers held such a small proportion was September 2007, a month before the S&P 500 began a 57 percent drop...

For balance, they quote unnamed bulls who point to $3 trillion in money market funds that retail investors could unleash on the stock market if there's a pullback.

Barry Ritholtz of The Big Picture also comments on this.

Mutual fund managers have to keep a certain amount of cash on hand, to fund the normal redemptions that happen every day. The holdings have varied over time, from today's low 3.6 percent to over 10 percent. They were almost this low during 2005 and 2006, without apparent ill effect (see below).

If cash is low, and investors suddenly head for the exits in reaction to a sudden market drop, mutual funds might have to raise cash and sell stocks, naturally hurting prices. No argument there.

On the other hand, investors have had a lot to react to lately, such as last week's employment news, and fourth quarter 2009 earnings, and the results have been positive. The low cash reserves means they've been buying, suggesting they're optimistic.

Another point is that cash reserves have been decreasing over time, probably in reaction to the growth in the size of equity mutual funds -- they only need to keep so much on hand. Look at the second column on the right hand side of the page, from the Investment Company Institute's 2009 Fact Book:


Click on the graphic for a larger version
My take: this cash low-water mark is an interesting fact, but I don't think it puts any pressure on the market all by itself. If the economy comes up short and people start selling stocks, it may trigger more selling, but that's a separate fundamental cause-and-effect.

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February Jobs Report
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A Bottom-Up Look at GDP in 4Q 2009

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