It is axiomatic in the mutual fund industry that what are considered normal cash positions should be between 3% and 5%. This affords liquidity to meet redemptions from fund shareholders, which commonly run at about 25% of assets annually, and for the opportunistic purchase of long-term assets. Today, however, the equity markets are at or approaching all-time highs in the US and Europe and interest rates are at extraordinarily low levels and rising. The Shiller 10-year inflation-adjusted PE ratio is 24, well above the historical mean since 1880 of 16.5, and Shiller predicts an average real return of only 3% annualized over the next 10 years. This analysis suggests that the risk of negative future returns for risky long-term assets is higher than normal. However, above-average valuation and interest-rate risk do not appear to be reflected in todays mutual fund cash positions.
Particularly when stock and bond valuations are extended, cash is an important strategic asset. The clear sense of the committee was that cash should be husbanded. By doing so, the investor will be able to profit from what might otherwise be long-lasting or permanent reverses. The committee concluded that 30% was an appropriate cash position today.
* Roger G. Ibbotson and Rex A. Sinquefield, The Journal of Business, Vol. 49, No. 1 (Jan., 1976), pp. 11-47