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An X Ray of Money Market Fund Risks

by François Masquelier, Chairman, ATEL (Association des Trésoriers d’Entreprises du Luxembourg) and Philippe Debatty, CAIA, Managing Director, Alternative Advisers S.A.

1. Reducing the inherent risks in money market funds

When investing surplus liquidity, the main objective of a corporate treasurer is to guarantee recovery of the principal sum – unfortunately no simple matter in the current market. A treasurer will have seen the limitations of rating agencies. A triple “A” rating is an “extra” guarantee, but not enough for an investor. The guidelines set by the French market regulator “AMF” also seem insufficient to provide assurance about the quality of an investment. This problem does not therefore come down solely to the Anglo-Saxon classification “Treasury-Style Money Market Funds (MMF)” versus “Investment Style MMF”. The idea behind the analysis conducted with the help of Alternative Advisers was to assess the inherent risk in each of a client’s portfolio funds, thus going beyond the simple analysis of accounting treatment alone, by relying on multi-factor analyses.

2. Risks linked to a money market fund

A money market fund is exposed to two types of risk: the interest rate risk, which can fluctuate to a limited (but real) extent, and the counterparty risks which – during a period of crisis such as the situation during autumn 2008 – can become enormous. We believe it would be helpful to study this second risk type as even if a rating agency specifically targets the credit risk, the score awarded does not prevent the inherent risk for the MMF. 

Fund pooling reduces the impact in the event that the risk arises, but rather than eliminating it, it conversely increases it. Investing in a fund means “outsourcing” its management to an independent professional (subcontractor) and diversifying the risks in order to reduce the potential impact.   

This method can thus be a helpful decision-making tool to complement the process of selecting a monetary fund. The analysis can be conducted regularly, on a random basis, to “scan” the investment portfolio. The consultant offers to provide global “top-down” classification reports on the MMF, in terms of risk quality. In the current economic climate and taking into account the prevailing volatility, such a tool could help support a company’s short-term investment policy. After all, you can never be too careful when it comes to entrusting your money to others.