Equity Mutual Funds Keep Powder Dry As Global Volatility Spikes

Indian equity mutual fund managers held cash worth over Rs 90,000 crore at the end of September, according to Morningstar data, as geopolitical crises and soaring bond yields fuelled a risk-off sentiment.

"Most equity funds tend to be fully invested with cash levels ranging from 3–5%," Radhika Gupta, chief executive officer of Edelweiss Mutual Fund, said. "In certain mid- and small-cap funds, because of the way either markets have moved, or the own fund's liquidity situation has panned out, cash levels may have risen to 5–10%, which is what you're seeing."

"So certainly, there is some dry powder for people to invest," Gupta said.

The mutual fund industry witnessed a surge in inflows into actively managed mid-cap and small-cap funds so far this year. Retail investors pumped in over Rs 45,000 crore into such schemes in the first nine months. Large-cap actively managed schemes saw an outflow of Rs 3,717 crore, according to data released by the Association of Mutual Funds in India.

Currently, several small and mid-cap fund managers are holding cash of more than 5% of assets under management, Kaustubh Belapurkar, director–research at Morningstar India, said in an interview with BQ Prime. This is usually done when fund managers are uncomfortable with valuations or are dealing with inflows that are unanticipated, he said.

The nature of the underlying stocks that these schemes invest in has also forced fund managers to look further afield to find stocks to invest in.

"The number of stocks in portfolios is going up, specially in the mid- and small-cap segments," Himanshu Srivastava, associate director–research, Morningstar India, said. "That could be because of capacity constraints and because of the flows."

"For a fund manager, it is important to maintain liquidity in a portfolio," Srivastava said.

Stability Amid Foreign Outflows

Equity markets in India saw outflows from foreign institutions in October as geopolitical tensions and a rise in bond yields in the U.S. resulted in fund flows away from emerging markets. Israel declared war on militant group Hamas after militants killed Israeli civilians and took hostages on Oct. 7. The threat of an escalation beyond the Gaza region has kept global markets on the edge.

In the intervening weeks, yields on U.S. Treasuries rose to 16-year highs, with the yield on the 10-year paper even rising above 5%.

In this context, with foreign investors selling, inflows by way of systematic investment plans have been a boon, not just for the mutual fund industry, but also for the Indian capital market, according to Gupta.

"I don't think at an industry level, in equity funds, cash levels have risen alarmingly. I think what is more exciting… is that we get (Rs) 16,000 crore of monthly flow (through SIPs)," she said. "In some way, we are making our markets more self-reliant and that bodes well."