Indian equity funds' allocation of cash relative to their asset size rose to a 5-year high at the end of August, as fund managers are worried about markets being too rich and other macroeconomic risks around U.S. elections and Chinese growth.

According to Morningstar data, active equity funds in India with a fund value of at least $1 billion held an average of 5.39% of their portfolios in cash as of end-August, their highest levels in five years.

"While the market has been performing well, there are potential risks such as economic slowdown, interest rate regime change, geopolitical tensions and market overvaluation," said Sonam Srivastava, founder and fund manager at Wright Research.

Although the rise in cash levels is partly due to inflows and the launch of new funds, caution is also a factor.

"The elevated cash levels among fund managers may suggest an expectation of a potential stock market correction as they seek to mitigate losses," said Mahesh Patil, chief investment officer at Aditya Birla Sun Life Asset Management Company. "This could reflect caution around the rapid rise in markets, especially since there has been no major shift in fundamentals to justify the surge," he said.

After lacklustre earnings growth in the first quarter of this fiscal year, which saw more than half of Indian companies miss consensus earnings expectations, fund managers are also worried about valuations.

"There are valuation concerns as pockets of markets are looking over-stretched," said Abhishek Goenka, founder and chief executive of IFA Global.

The forward price-to-earnings (P/E) ratio for MSCI India's large-cap index is at 22.8 times, an 18.6% premium to the 10-year average, while the MSCI India mid-cap index is trading at a 67.7% premium and the small-cap index at about 40% premium to their respective 10-year averages.

"Currently, valuations for mid-caps look elevated, hence, there might be a possible correction in mid-caps," said Anil Rego, founder and fund manager at Right Horizons.

Morningstar data showed the ICICI Prudential Value Discovery Fund, with a fund value of about $5.9 billion, saw its cash allocation climb to 14.7% by the end of August from 7% at the beginning of the year.

Similarly, the SBI Long Term Equity Fund, which has a fund value of $3.3 billion, increased its cash holdings to 9.8% in August from 4.46% at the start of the year. The Quant Small Cap Fund, valued at $3 billion, also saw its cash allocations rise significantly to 15.7% in August from just 2.15% at the start of the year.

However, some analysts don't believe that these high cash levels portend a market crash.

"Usually, bouts of deep correction happen when the markets are fully invested. If the markets are circumspect and exercising caution, we may see 3%-5% corrections getting bought into. The cash will start getting deployed and that would support the markets," Wright Research's Srivastava said.

"Nevertheless, there could be a stalemate wherein market remains sideways for a significant period of time, thereby testing investors' patience."

 

(Reporting By Patturaja Murugaboopathy and Bharath Rajeswaran, with Additional Reporting by Gaurav Dogra in Bengaluru Editing by Vidya Ranganathan and Sonia Cheema)