Indian equity funds' cash holdings reach 5-year high amid valuation concerns

Indian equity funds are holding their highest cash reserves in five years, reflecting fund managers' growing caution over elevated market valuations and potential macroeconomic risks. According to Morningstar data, Indian active equity funds with assets of at least $1 billion had an average of 5.39 per cent of their portfolios in cash by the end of August 2024, marking the highest levels since 2019.

The caution stems from several factors, including concerns over global economic conditions, geopolitical tensions, and domestic market overvaluation. "While the market has performed well, risks like economic slowdowns, changing interest rate regimes, geopolitical tensions, and market overvaluation persist," said Sonam Srivastava, founder and fund manager at Wright Research.

Though the increase in cash levels is partially attributed to new fund inflows, the underlying sentiment among fund managers is one of prudence. "The elevated cash levels suggest fund managers expect a potential market correction and are seeking to mitigate possible losses," said Mahesh Patil, chief investment officer at Aditya Birla Sun Life Asset Management Company. Patil highlighted that the market's rapid rise hasn't been matched by significant improvements in fundamentals.

This cautious approach follows a weaker earnings performance in the first quarter of the fiscal year, where over half of Indian companies missed earnings expectations. "Valuation concerns are growing, particularly in certain sectors that appear overstretched," noted Abhishek Goenka, CEO of IFA Global.

The forward price-to-earnings (P/E) ratio for MSCI India's large-cap index stands at 22.8 times, an 18.6 per cent premium over its 10-year average. Mid-cap and small-cap indices are trading at even higher premiums of 67.7 per cent and 40 per cent, respectively.

Fund managers are adjusting their portfolios accordingly. For instance, ICICI Prudential Value Discovery Fund, valued at $5.9 billion, increased its cash allocation to 14.7 per cent by August, up from 7 per cent at the start of the year. Similarly, SBI Long Term Equity Fund and Quant Small Cap Fund also saw significant increases in their cash reserves.

However, some analysts argue that these high cash levels don’t necessarily indicate an impending market crash. "When markets are cautious and holding cash, corrections of 3 per cent-5 per cent are typically bought into, which stabilises the market," said Wright Research's Srivastava. Nevertheless, she warned that prolonged market stagnation could test investors' patience.

(With Reuters inputs.)