As market rises, some funds are holding on to cash

[September 16, 2013]  NEW YORK (AP) -- Sell high.

That's what managers of some mutual funds say they're doing after watching stock prices soar. The Standard & Poor's 500 index has surged nearly 50 percent in the last two years and nearly 150 percent since the market's bottom in March 2009.

That's led managers, particularly those who look for stocks that are cheap relative to their earnings, to sell some of their stocks and wait for prices to fall before buying again. If they're right, they'll have protected their investors and have more cash with which to buy stocks on sale. If they're wrong and stocks keep rising, their investors will miss out on the gains.

"We've made some money, and we're taking some chips off the table," says Sandy Villere. For the last five years, his Villere Balanced fund (VILLX) has returned an average of 14 percent annually and ranks in the top 1 percent of its category, according to Morningstar.

"What do they say? Pigs get fat, and hogs get slaughtered," Villere says.

The fund has been selling stocks since May and leaving the proceeds parked in cash. That means cash now makes up 12 percent of its $849.5 million in assets. Historically, cash has been below 5 percent of the total.

Other managers have joined Villere, albeit not to the same degree. Fund managers have an average of 4.5 percent of their portfolios in cash, up from 3.8 percent in January, according to the most recent survey data from Bank of America Merrill Lynch. In July cash was at 4.6 percent, a one-year high.

Holding cash isn't necessarily a red flag, says Todd Rosenbluth, director of mutual fund and ETF research for S&P Capital IQ. Mutual funds always have some on hand, ready to return to investors who may be selling their shares.

Rosenbluth says he considers a fund fully invested as long as it has up to 5 percent of its assets in cash. Once it gets over 10 percent, he says investors should ask why and check to see if it has had a good history doing so.

Villere has been selling stocks because he says there are fewer that meet his criteria. He wants companies with high earnings growth and low stock prices relative to their earnings, among other things. If a company's earnings are growing at 18 percent annually, he wants its stock price to be less than 18 times its earnings per share, for example.

Such stocks have been tougher to find as prices climb faster than companies are growing their earnings. The S&P 500 index trades at 15.2 times its earnings per share over the prior 12 months, according to data provider FactSet. That's up from 11.9 times two years ago. It's also slightly higher than its average of 14.9 times over the last 10 years.

Many managers say they're raising cash in anticipation of a temporary, modest pullback. They're not looking for a market crash, like the 38 percent decline of the S&P 500 in 2008 amid the financial crisis.

Some investors say the S&P 500 is due for a drop of at least 10 percent, which is called a correction in trader-ese. The index hasn't experienced one since 2011, though it had a 6 percent drop between May 21 and June 24.

Economists also expect the Federal Reserve to soon announce a paring back of its bond-buying stimulus program for the economy, perhaps as early as its next policy meeting, which ends Sept. 18. The Fed's efforts have helped to keep long-term interest rates low.

The S&P 500 has climbed 18 percent in 2013 -- more than it has in 11 of the last 13 full years -- and many forecasters on Wall Street expect more gains from stocks in the coming months. Strategists at Deutsche Bank and Goldman Sachs predict the S&P 500 to end the year at 1,750, for example. That would mean a 4 percent rise from its 1,683.42 closing level on Thursday. Barclays is more skeptical, forecasting the S&P 500 will fall and end the year at 1,600.

Here are some factors investors should keep in mind when considering stock mutual funds building up their cash levels:

• It can mean a higher tax bill. When mutual funds sell stocks, they must record how much profit or loss they made on the investment. At the end of the year, they tally up all the gains and losses, and they distribute those to their investors. So fund investors could receive a capital gains distribution and owe taxes on it, even if they didn't sell any shares of the mutual fund themselves.
  
  The top rate on long-term capital gains is 23.8 percent this year after including a new tax on the highest income earners to help pay for the federal government's health care overhaul. That is up from a top rate of 15 percent last year.

• You're paying someone to hold cash. When a mutual fund holds cash, it is still charging its expenses to cover its managers' salaries and other operating costs. The average U.S. stock mutual fund has an expense ratio of 1.26 percent, which means that it deducts 1.26 percent of the fund's total assets annually for expenses.

[Associated Press; By STAN CHOE]

Copyright 2013 The Associated Press. All rights reserved. This material may not be published, broadcast, rewritten or redistributed.