Cash Drag

A fund rarely holds exactly 100% of its assets invested at all times — some cash sits around to meet redemptions, wait for a trade to settle, or simply because a manager hasn't yet deployed a fresh inflow. Cash drag is the performance cost of that idle portion: if the fund's strategy would have returned 12% for the year but 5% of assets sat in cash earning 4%, the fund's overall return is pulled below 12% purely because a slice of the portfolio wasn't participating in the higher-returning strategy.

The size of the drag depends on both how much cash is held and how large the gap is between the strategy's return and the cash rate. If a fund holds 5% in cash, the strategy returns 12%, and cash earns 4%, the blended return is approximately $0.95 \times 12\% + 0.05 \times 4\% = 11.4\% + 0.2\% = 11.6\%$ — a drag of about 0.4 percentage points versus being fully invested. In periods when short-term rates are low, cash drag is a near-pure cost; when rates are elevated, it can be small or even help if the strategy itself is having a weak stretch.

Cash drag is a standard line item in performance attribution reports, separating "return the manager earned by security selection" from "return lost or gained simply by not being fully invested." Funds that must hold larger cash buffers — for daily redemptions, say — structurally carry more of it than closed-end vehicles with locked-up capital.