Business Intelligence

Excess Cash And Mutual Fund Performance

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Executive Summary

The author documents a positive relationship between excess cash holdings of actively managed equity mutual funds and future fund performance. The difference in returns of portfolios of high and of low excess cash funds amounts to over 2% annually, or approximately 3% after standard risk adjustment. The author studies whether this difference in performance can be explained by the differences in managerial stock selection skills, market-timing abilities, fund liquidity needs, and operating costs. The author shows that managers of high excess cash funds make more profitable stock purchasing decisions, while low excess cash fund managers make better sell decisions. Neither high nor low excess cash groups exhibit significant market-timing skills; however, funds with volatile excess cash holdings are successful market timers.

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