What Is Mutual Fund Liquidity Ratio?

A ratio of a mutual fund's cash and cash equivalents to the assets in which it is currently invested. That is, if a mutual fund has a large amount of cash that it has not invested in securities, the ratio is higher, while, if all or nearly all of its liquidity is invested, the ratio is lower.

A high ratio is considered a bearish indicator because it means that the mutual fund is having difficulty finding investments with solid returns, and is therefore keeping larger cash reserves. Mutual funds publish liquidity ratios each month.

The mutual fund liquidity ratio is used by equity investors to gauge the demand for shares and the bullishness or bearishness of portfolio managers.

For example, if a mutual fund is sitting on a large amount of cash, the theory is that it is doing so because it is hard pressed to find quality investment opportunities therefore, it has a bearish sentiment towards the market.

Conversely, if a mutual fund is highly invested and has a very small amount of cash on hand, the theory is that it has found some excellent investing opportunities and is taking advantage of these opportunities by being nearly fully invested - that is to say, it is bullish.

The main reason to maintain the liquidity (cash reserves) is to meet the redemption requirements of customers. Not all customers would want to remain invested always. As the fund house has the responsibility to honor the redemption requests, they need to maintain cash reserves using which they would pay those customers.

Liquidity ratio in a mutual fund house is the amount of money they maintain as cash or near cash instruments.