Regulating cash holdings: Assessing lost returns in mutual funds^✰

Mutual funds have traditionally attracted retail investors seeking diversified market exposure. While the focus has historically been on asset liquidity and quality, recent attention has turned to assessing fund liquidity and the risks of asset fire sales. Our study analyzes Israeli mutual funds’ daily holdings and flows over an extensive eight-year period, revealing a significant issue: fund managers tend to maintain excessive cash levels, burdening the industry by more than 2 % of assets under management (AUM). These findings highlight the urgency of implementing advanced liquidity management tools to navigate redemption risks effectively. Moreover, our research stresses the need for flexible, market-oriented regulations and enhanced industry transparency. By establishing liquidity risk management guidelines, regulators can optimize investor returns and mitigate potential systemic risks associated with cash allocations in mutual funds.