The Cash Call Paradox: Does Holding Cash Protect You, or Just Cost You Returns?

Some of India's best-known equity funds have, at various points, parked a fifth of their money in cash while the market kept climbing. To one investor, that looks like discipline. To another, it looks like paying an active manager 0.5% a year to not invest. Both reactions are reasonable, and that is exactly what makes cash calls one of the most misunderstood decisions a fund manager makes.

So which is it? Does a large cash pile actually protect you, or does it quietly bleed your returns? The honest answer is: it depends on what the cash is for, and the evidence is far less flattering to "market timing" than the industry's marketing suggests.

The Case for Cash

Every open-ended equity fund holds some cash simply to function, usually 1–5%, so it can meet redemptions without dumping stocks at bad prices. That much is plumbing, not strategy. The debate begins when cash climbs well above that, into the 15–25% range.

The argument in favour is genuinely strong. Cash falls far less than equities in a crash, so a fund holding 20% cash mechanically loses less when markets drop, cushioning the investor. It is also "dry powder", money ready to buy quality stocks at a discount when others are forced to sell.

And there is real evidence that this can work. PPFAS, whose flagship flexi cap fund has repeatedly run cash near 20%, credits high cash levels with helping it through the 2018 market turmoil and the 2020 pandemic correction, and the fund has still ranked among the top performers in its category over ten years. Held with discipline, cash has clearly protected investors at the moments that mattered most.

The Case Against Cash

Now the other side. In a rising or even a flat market, cash is a drag by construction. Money not in equities does not earn equity returns, so a cash-heavy fund almost guarantees itself lower returns than a fully invested peer whenever markets rise. PPFAS itself has felt this recently: through a long range-bound stretch where, in its own words, the Nifty 500 "has gone nowhere," its cash has weighed on results and drawn open criticism.

But the deeper problem is not the drag in any single year. It is whether managers can actually time these calls, raise cash before falls, and deploy it before rallies. On this, the academic record is unusually consistent and unusually blunt: fund managers, as a group, do not have reliable market-timing skill. A foundational US study found that equity funds as a whole show no ability to forecast market returns through their cash holdings, and Indian research reached the same conclusion: attempts to use cash for timing generally do not produce the hoped-for gains. If the timing doesn't add value on average, then on average the cash is just a cost.

Resolving the Paradox

The two sides seem to contradict each other, but they don't; they describe two different reasons for holding cash, and the distinction is the whole point.

Cash held as a by-product of discipline tends to help. This is the PPFAS framing: their manager, Rajeev Thakkar, has been explicit that cash is a residual of not finding stocks worth buying at current valuations, not a bet on where the market is heading. When a manager refuses to overpay, and cash simply accumulates because nothing is cheap, that cash reflects a valuation process, and it has historically protected investors when expensive markets eventually corrected.

Cash held as an active market call, "I think the market will fall, so I'm selling", is the version the evidence treats harshly. It relies on a timing skill that studies repeatedly fail to find, and when the manager is wrong, which is often, investors pay twice: once in the rally they miss, and again in the fee they keep paying.

That is the resolution. The question isn't how much cash a fund holds. It's why it holds it.

What this Means for You

The takeaway is not "avoid funds that hold cash" or "seek them out." It's that a cash level is only meaningful once you understand the reason behind it. A few practical implications follow.

First, read the manager's stated philosophy, not just the percentage. A fund that treats cash as a valuation-driven residual is a very different proposition from one making tactical bets on market direction, even if both show 18% cash this month. Second, judge cash-heavy funds over a full market cycle, not a single year. Their whole thesis is downside protection, which only reveals itself in a downturn; praising or damning them on one rising year misses the point entirely. Third, remember the drag is real regardless of intent, so a permanently high cash level in a fund sold as "fully invested equity" is a mismatch worth questioning; you may be paying equity fees for a partly-debt allocation you could build more cheaply yourself.

Cash calls are neither the virtue their fans claim nor the failure their critics allege. They are a tool, protective in disciplined hands, expensive in overconfident ones. The number on the factsheet won't tell you which kind you're holding. The manager's reasoning will.