A New Focus on Money Market Funds
by Chris Cheetham, CEO Halbis, HSBC
Over the past couple of years, as a result of the turmoil in financial markets, investors’ attitude towards cash as an asset class has gone through a fundamental change. Before the liquidity crisis, cash was generally regarded as the least risky asset class, but events of the past eighteen months, in particular the drying-up of liquidity in money market instruments and the failure of a US-based money market fund in the wake of the Lehman bankruptcy, have served as a timely reminder to investors that cash is not risk free.
As a consequence, money market funds are currently under more scrutiny than ever before, and the onus is on managers to demonstrate that they have a robust investment strategy and process that will be effective in all kinds of market environments. Money market funds operate in a different way from other types of funds, as rather than concentrating on producing a return (often against a defined benchmark), their primary objective is to return capital to investors on demand, which means that their focus is the preservation of capital and the provision of liquidity, with yield as a secondary consideration. Of course there remains a risk that money market funds will not meet this primary objective, particularly when the market is in dislocation.
Rigorous investment process
Investment managers manage this risk through a rigorous investment process. At HSBC, the investment process for our Liquidity fund range is designed to help the funds attain their stated investment objective: ‘to provide investors with security of capital and daily liquidity together with an investment return which is comparable to normal…money market interest rates’. The first part of the objective (‘…security of capital and daily liquidity…’) deals with credit and liquidity risk. It means that the starting point of our process is to constrain our investable universe to those assets that we consider to be secure and liquid. The second part of the objective (‘…an investment return comparable to normal money market interest rates…’) is met by enabling our analysts and managers to seek out value within the investable universe.
We make our internal investment constraints highly dynamic so that we can adapt rapidly to changes.
Looking at the first part of the objective, our investment process manages credit and liquidity risk by imposing two types of constraint on our investable universe: external constraints (i.e., those imposed by rating agents, IMMFA and regulators) and internal constraints (i.e., those imposed by our own Credit and Investment Committee). External constraints comprise a large number of quantitative and qualitative requirements, for example: rating agents’ requirement to invest in A1/P1 paper, IMMFA’s requirement to maintain a WAM no greater than 60 days and the regulator’s requirement to appoint a third-party custodian to safeguard the fund’s assets. These external constraints are reasonably well understood by our investors and so provide them with reassurance that our fund meets minimum industry best practice.
While external investment constraints remain fairly static, changing only very infrequently, we make our internal investment constraints highly dynamic so that we can adapt rapidly to changes in the market environment. This has been particularly important during the market turmoil. For example, our Credit and Investment Committee maintains our Approved Counterparty List, and reviews it regularly. The list outlines our exposure and duration limits for those issuers that we judge to be of good credit. Every issuer on the list is monitored on an ongoing basis by one of our credit analysts, and overseen by the Global Head of Credit. This means that we can supplement rating agency research with our own independent assessment of credit risk, and respond rapidly to changing market conditions. For example, we removed Lehman Brothers from our Approved Counterparty List well before it had been downgraded by the credit agencies.