These Buyers Will Launch Stocks Higher

Anyone who stayed in cash during 2008 looked like a genius. But for fund managers who've kept money on the sidelines this year, the pressure's on to get fully invested -- and when those holdouts start buying, they'll likely push stocks even higher.

What really matters
The key to understanding the predicament that fund managers are in right now is that in the money-management world, your absolute performance isn't nearly as important as how you do compared to your competitors. Funds that lost 25%-30% in 2008, for instance, looked great in comparison to peers that lost 40% or more -- even though everyone lost a lot of money. When times are bad, you don't have to earn gains to keep your job as a fund manager.

On the other hand, when stocks recover, your cash holdings don't just dampen your absolute returns. They also hold you back as the competition soars past you. And while cash looked like a great choice back in early March, when the S&P had dropped another 25% since the beginning of January, it's looking less and less attractive as stocks turn positive for the year.

Who's got cash?
For the most part, if you want to find mutual funds that still have money to invest, you'll want to focus on actively managed funds. Index funds can't afford to keep cash on hand, as anything more than a tiny amount of cash will cause a significant tracking error relative to the fund's benchmark -- especially when stocks are rising strongly, as they have recently.

Active funds, however, have the flexibility to hold substantial amounts of cash. Although investors don't like it when funds always hold a lot of cash -- why pay stock fund expense ratios of 1% or more on money that's not even invested? -- they understand that successful managers have to wait for the right opportunities to buy the right stocks at the best price.

A quick look at some popular mutual funds reveals that quite a few have held sizable cash holdings recently:

Source: Morningstar. Holdings data as of March 31.

Just looking at these three funds, you'll find more than $10 billion in cash, much of which those fund managers will eventually put into the stock market.

Where's that money going?
Of course, once you find funds that have cash to spend, the next step is trying to figure out which stocks will benefit when they finally put their money to work. That's a challenge, because mutual funds report their holdings on a delayed basis. By the time you find out what a fund bought months earlier, it's too late to try to anticipate their actions.

However, there are a few things you can look for:

• Watch what managers like. By looking at regular reports of fund holdings, you can see which stocks fund managers are buying and which they've pared down since the last report. Those favorite stocks are likely to get more interest if a particular fund manager can't find a new idea for an investment.
• Stick to the industry. Another strategy is to focus less on exactly which stocks a fund buys, instead looking at the general industry. For instance, the funds above all have their eyes on technology stocks, so one idea is to look not just at the big names listed above but also at other stocks that might benefit from similar trends.

By understanding how fund managers respond to changing market conditions, you can anticipate their investment moves. That kind of edge can help you take advantage of their expertise -- and potentially beat them to the punch in buying the stocks they like.

For more on finding the right funds, read about:

• You should jump on this opportunity before it disappears.
• Don't blow this great chance to invest.
• One way you can beat the market.