What Is a Mutual Fund Liquidity Ratio?
A mutual fund liquidity ratio is a ratio that compares the amount of cash in a fund relative to its total assets. Mutual fund liquidity ratios can vary and may include cash or cash equivalents.
- A mutual fund liquidity ratio is a ratio that compares the amount of cash in a mutual fund relative to its total assets.
- Depending on how a mutual fund ratio is calculated by a specific fund, the cash levels can include just cash or also cash equivalents.
- Mutual funds need to find the right balance of cash levels; too much cash means money is not being invested, losing out on returns, while too little cash means a fund is not liquid enough to meet expenses and unexpected cash needs.
- Most funds keep approximately 3% to 5% of their total assets in cash.
- Investors may follow mutual fund industry liquidity ratios to get a sense of money managers’ collective perspective on the market. Liquidity ratios greater than 5% indicate a bearish outlook while ratios below 5% indicate a bullish outlook.
- In December 2018, the Securities and Exchange Commission (SEC) began issuing new rules related to mutual fund liquidity management and monitoring funds' adherence to these rules.
An Introduction To Mutual Funds
Understanding a Mutual Fund Liquidity Ratio
A mutual fund liquidity ratio is reported by mutual funds to provide investors with insight into how much cash the fund is holding. Companies may report cash ratios or cash and cash equivalent ratios, which is a broader measure encompassing cash equivalents that can be easily liquidated within a short period of time. The ratio is a simple percentage dividing either the total cash or the total cash and cash equivalents by the fund’s total assets.
Mutual fund cash levels are also followed closely by industry speculators as an indication of the market’s direction. Most funds keep approximately 3% to 5% of their total assets in cash.
Finding the right cash balance is important for a mutual fund and its investors. Having too much cash on hand, meaning cash that is not invested, is not a useful deployment of investment capital as it defeats the purpose of investing. Investors provide their cash to mutual funds so that they can be invested and generate a return, most often through capital appreciation, rather than having it sit idly.
Having some levels of cash is important as it allows for liquidity. Investments can take time to unwind, therefore, doing so to meet cash requirements can be risky if the investments are currently at a loss. Therefore, having cash on hand to meet unexpected cash needs or to pay for operating expenses is a prudent measure.
The Investment Company Institute provides a monthly report on mutual fund industry statistics, which includes information on the mutual fund industry’s average mutual fund liquidity ratio. In May 2021, the Investment Company Institute reported a liquidity ratio across equity mutual funds of 2.1%.
Generally, investors may follow mutual fund industry liquidity to get a sense of money managers’ collective perspective on the market. Liquidity ratios greater than 5% are expected to show some fear in the market’s prospects for gains with a bearish outlook. Liquidity ratios below 5% tend to show that money managers are more bullish on the markets and fully deploying all cash.
Mutual Fund Cash Regulations
Until 2016, mutual fund cash levels and mutual fund liquidity were not factors that were highly regulated. However, in 2016 the Securities and Exchange Commission (SEC) issued some new rules pertaining to mutual fund liquidity management.
The agency’s new rules went into effect in December 2018, adding some new provisions to the Investment Company Act of 1940. Changes are primarily focused around Rule 22e-4, which requires funds to document a comprehensive liquidity program and invest no more than 15% of their net assets in illiquid investments.
Other changes include amendments to mutual fund registration Form N-1A as well as changes to Form N-LIQUID, Form N-CEN, and Form N-PORT. With the new rules, the SEC is seeking to help investors more easily buy and redeem shares while also instituting some new parameters for liquidity risk management and cash position reporting.