Focus on ensuring liquidity

Money market funds hit the headlines last year as investors became fully aware that not all funds invest in a similar range of instruments. The collapse in September of Reserve Primary Fund, the mutual that held $785m (E609m) in Lehman commercial paper and was the first such fund to break the buck for 14 years, focussed attention on the underlying investments in these funds. Investors fast became aware of the differences between products and fled to the safety of Treasury and gilt funds. “During September last year dollar-denominated money market funds in Europe lost 15 per cent of their assets under management as a response to the troubles experienced onshore,” estimates Hugh Briscoe, European product manager for GSAM’s Global Liquidity Management team. “Around $70bn went into Treasury funds in September and October and very little of that has left. The fact that we have not seen a significant outflow from the safety of government debt tells us that investors continue to be cautious,” he explains. Managers are now taking pains to ensure the liquidity of their funds. “What’s changed is that investors and providers are focussing on security and liquidity instead of searching for a few extra basis points,” says Jonathan Curry, head of European cash management at Barclays Global Investors. The BGI Sterling Liquidity First Fund currently has a weighted average maturity of around 15-20 days compared with 30-50 days in normal markets, for example, while 18 months ago, around 20 per cent of GSAM’s Liquid Reserve fund was in overnight instruments, but that level has since been boosted to 37 per cent. “We’re very conscious of the general decline in the credit quality of many issuers and this has also led us to shorten the maturity profile of our portfolios as well, of course, as continuing to ensure an intensive assessment of credit quality,” says Chris Cheetham, CEO of Halbis, the active management specialist within HSBC Global Asset Management. “Although this approach to investment strategy has led to lower yields than might otherwise have been achieved, we strongly believe that a conservative strategy is in the best interests of our clients to whom we are committed to providing both security and liquidity,” he adds. The more liquid funds were in a better position than their peers to handle large redemption requests last year, but for some, liquidity proved hard to regenerate in volatile markets, exacerbated by investors being able to look at the fund and see for themselves when assets would be maturing. The majority of flows into government-only funds have been from US$ money market funds into US$ Treasury funds because dollar investors appear most nervous, says Mr Curry. The US remains the toughest market. “A lot of the flows went to US Treasury strategies which may be seen as more secure so the assets were not necessarily lost by fund complexes,” says GSAM’s Mr Briscoe. “But at the same time we have seen interest rates fall in Europe and the UK. The Fed Funds target rate is now very low and this is impacting US Treasury funds which may struggle to generate returns after management fees,” he explains. The Federal Reserve last month lowered its target overnight lending rate to a range of zero to 0.25 percent. Since money funds must maintain an average maturity of 90 days or fewer, their yields respond quickly to changes in short-term rates, usually with a short lag. This prompted Vanguard Group, for example, to close its main US Treasury $8.3bn Treasury Money Market Fund and the $27bn Admiral Treasury Money Market Fund to new accounts in late January, citing a need to protect existing shareholders as treasury yields hover close to zero. The next interesting trend will be when investors pull out of government assets in significant numbers, but that does not look like being any time soon. “Interest rate policies are currently managed at the expense of liquidity policy - especially in the US,” says Stefan Kreuzkamp, fund manager at DWS Investment. “In Europe, the situation is less drastic. We expect the ECB to set the rate between 1 and 1.5 per cent. In the US, interest rate policy will remain unchanged until 2010. Until then, the Fed will support the market with liquidity. A solid money market fund should produce a performance of 1.5 and 1.6 per cent.” “In these times, it is essential to pick the right issuers which will survive the crisis,” Mr Kreuzkamp adds. “We are invested in credits from solid, well financed blue chip companies such as BASF, Unilever, Eon and Daimler. An asset class which represents substantial opportunities due to the fact that their image is tarnished are asset backed securities. Again, it is important to pick top-notch securities - and to run an analysis independent from the rating agencies.” Safety first Fund managers are now questioned much more closely about their processes and assets. “Presently, investors are looking for safety and top quality portfolios and are less interested in yield enhancement,” says Leonardo Brenna, who manages the UBS money market fund. “This is reflected in that more than 93 per cent of outstanding ECPs (Euro commercial paper) are rated A1/P1 with A1+/P1 (highest possible quality) increasing from 64 per cent in 2007 to 77 per cent in 2008,” he explains. “Investors are ready to pay for quality and this can be seen in the fact that pre-credit crunch the difference in investing in A1+/P1 to A1/P1 ECP paper was a couple of basis points and the issuing level was around Libor -6 to -12 basis points, while now the difference is more widespread and the issuing level between AAA to A can vary from Libor -10 to more than Libor -100, depending on the quality of the company. Flight to quality or safety in investing, therefore, has its price,” says Mr Brenna. While volatile markets present opportunities, independent research is more crucial than ever. “Opportunity-wise, due to de-leveraging and the shrinking balance sheet of many financial institutions, we are able to buy short-dated cheap top quality paper in the market,” he adds. “The market will be facing a downward rating trend as far as issuers are concerned, due to where we stand in the credit cycle. Therefore independent buy side credit research will become more important in order to avoid negative rating migration,” explains Mr Brenna. Further rate cuts are also expected in Europe, exacerbating the difficulty of running these funds. “We expect more ECB rate cuts, so in the near future money market rates will continue heading south,” says Jörg Sommerschuh who manages the Deka Opti-Cash fund. “One of the main problems relating to the current financial crisis is liquidity in the market and, moreover, the lack of trust in the interbanking markets. So investing becomes more and more challenging even in the short term markets,” he says. “This mirrors an ongoing process of a complete reevaluation of the intrinsic risks. A deeper analysis shows that the market (price) distortions can partly be explained by the following factors: liquidity, default risk, collateral type. On the other hand these markets offer good opportunities. Especially in these times you can find opportunities for relatively cheap high-quality investments,” explains Mr Sommerschuh. Continued inflows According to EPFR Global, money market funds continued to attract inflows during the first three months of the year, while both equity and bond funds were haemorrhaging redemptions. Of the $10,ooobn in fund assets EPFR tracks worldwide, money market funds gained $12.8bn in net inflows in a single week ending March 4, for example, compared with outflows across all equity funds, with Japanese and emerging market equity funds particularly badly hit. Japan equity funds suffered net outflows of $1.72bn in the same week, for example. While redemptions from equity funds have slowed compared with the same period in 2008 in absolute terms, as a percentage of assets under management all except Europe focussed funds are running ahead of last year’s pace. “There are different kinds of cash-like funds and short-term bond funds in the marketplace and when investors across Europe use these terms we need to ensure they compare funds with similar risk profile,” says Mr Curry at BGI, who is on the board of industry body, the Institutional Money Market Funds Association. The body aims to ensure that triple-A rated money market funds are not confused with similarly named funds in the IMA’s Money Market sector which incorporates a wide range of cash, near cash and short duration fixed income funds. “It is something that the Association, which represents providers of triple-A rated, stable net asset value money market funds, is addressing.” The issue of differentiating between funds is even more critical now that the market for these funds has broadened out from their traditional users. Historically, the users were largely the treasury departments of large corporates, but investors now recognise the default risk of financial institutions and have seen these funds as a way to diversify. They are now attracting individuals, smaller companies and hedge funds, both as a parking place as hedge funds wait to re-enter the stock markets and also as a place for asset managers to put aside cash to meet their own redemption requests. Outsourcing trends “Our fund is primarily marketed to corporate treasurers, as a means of managing surplus operational cash,” says Mr Cheetham at Halbis. “These remain the primary shareholders of the fund. We avoid marketing the fund to clients whose holding may be significantly more volatile than our primary shareholders, in order to better manage liquidity. There is some evidence that corporates who have previously been comfortable managing their own cash reserves are now more inclined to outsource to institutions with strong credit research and portfolio management credentials,” he adds. “One of the key parts of any process is not just monitoring your assets but also your liabilities,” says Mr Curry. “In theory any client can come and make a redemption request on the same day, so it is very important to manage and understand your client base, how they use the fund and their future needs for liquidity. It is important to build up a diverse client base and to ensure it is not too concentrated in the hands of a small group of investors, unless perhaps if it is internal captive money,” he explains.

Stefan Kreuzkamp, DWS Investment