Investment

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A Deeper Look: Establishing Proper Due Diligence for Liquidity Investment Over the past decade, money market funds have gained significant ground across Europe as a flexible, secure and rewarding alternative to bank deposits. Over the last five years alone, annual net inflows have averaged EUR52bn a year, with uptake dominated by financial institutions, corporates, sovereign wealth funds and pensions. During this period of growth, money market funds have – like deposits themselves – largely been treated as a commodity. Yield has often been viewed as the key differentiator, followed by a fund’s credit rating. Beyond this, little attention has been generally paid to the internal mechanics of funds or the institutions that manage them...

A Deeper Look:

Establishing Proper Due Diligence for Liquidity Investment

by Kathleen Hughes, Head of Global Liquidity EMEA, J.P. Morgan Asset Management

All funds are not the same

Over the past decade, money market funds have gained significant ground across Europe as a flexible, secure and rewarding alternative to bank deposits. Over the last five years alone, annual net inflows have averaged EUR52bn a year, with uptake dominated by financial institutions, corporates, sovereign wealth funds and pensions (source: iMoneyNet, 30 April 2009).

During this period of growth, money market funds have – like deposits themselves – largely been treated as a commodity. Yield has often been viewed as the key differentiator, followed by a fund’s credit rating. Beyond this, little attention has been generally paid to the internal mechanics of funds or the institutions that manage them.

But as recent events in credit markets have shown, all liquidity funds - even AAA-rated ones - are not built the same. Factors such as what a fund invests in, how it is constructed and who it is managed by, have been shown to have a real and significant impact on the performance, liquidity and security of investor capital.

Credit rating agency Moody’s reports that, in the US, 36 money market funds registered under SEC Rule 2a-7 had to be supported by their sponsors in 2007/08 to avoid their net asset value (NAV) falling below USD 1/share as the value of certain underlying investments were wiped out.

Whatever the size of an organisation, every company needs an up-to-date investment policy governing its cash investments.

Such interventions are extreme and rare, but they have been sufficient for many corporations to reassess how and where their cash is invested and the processes and policies they have in place to govern these investments.

In this article we are going to outline the practical steps that organisations can take to help ensure that clear and fully-understood parameters are in place to safeguard the security of cash investments – particularly those held in third-party money market funds – while still enabling the benefits of active cash management to be fully realised.

Creating a cash governance framework

On reviewing their cash investments, some companies are discovering two things: first, there is no consistent and documented policy across the firm as to how it should be investing its cash. Second, the process for policing cash investments may be found to be inadequate.

For organisations that find themselves in this position, there are two key actions that need to be implemented as swiftly as possible:

First, an investment policy needs to be developed that clearly and fully documents the acceptable parameters of all cash investments – both direct investment in individual securities and indirect investment via pooled money market funds.

Second, a rigorous and systematic due diligence process needs to be enforced to identify money market funds that comply with the investment policy and are able to deliver the levels of security and liquidity expected by the firm.

We will outline what these two elements should each entail, and while these activities are likely to be led by a company’s treasury function (and investment committee, if it has one), it is strongly recommended that the chief finance officer and other board members take a high-profile and active involvement to help ensure a firm-wide commitment to the principles and steps agreed.

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