An increased focus on security and liquidity
Until the credit crunch of late summer 2007, markets were awash with cheap money. The resulting yield compression led risk to be significantly undervalued. Now as the fallout of the recent credit crisis continues to affect the markets and the financial system, investors have rediscovered the importance of security and liquidity and are now seeking a safe haven for their cash.

Choosing the right money market fund
Triple-A rated money market funds (MMFs) that are members of the Institutional Money Market Fund Association (IMMFA) are a convenient, secure and highly liquid safe-house for corporate cash, and many more companies are recognising the advantages of these investments, evidenced by the significant asset growth of these funds (fig 1). IMMFA provides the ‘gold standard’ for MMFs in Europe, but a difficulty for investors is that the term ‘money market fund’ covers a wide range of funds which are not equivalent in their asset security, diversification and the investment process employed by the fund manager.
When considering possible money market fund investments, it is vital that investors apply a series of key criteria to selecting a provider. These include:
The size of the fund: Has the fund sufficient assets to provide daily liquidity? Few companies enjoy entirely predictable cashflow, so cash has to be readily available to cover unforeseen circumstances. Although many funds will promote same or next-day settlement, MMFs with a small asset base will not be in a position to deliver on this commitment. Investors need to be satisfied that the size of the fund is sufficient both to deliver the liquidity it promises and achieve yield-enhancement through its economy of scale.
Diversification within the fund: There are two elements of diversification which are important for investors - asset diversity and investor diversity. Investors have become increasingly focused on the assets underlying the fund since the credit crisis first hit, and are seeking greater reassurance in the quality of the assets. However, it is also essential from a liquidity and security perspective that the fund has a sufficiently diversified investor base. A fund that is too reliant on one or few large investors is inherently less attractive than a broader investor base, ideally across different industry sectors, as a narrow investor base increases the potential for large-scale redemptions that will inevitably reduce liquidity, security and performance of the fund.
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The credit rating of the fund: Cash is the lifeblood of every organisation so companies need to take the greatest care over it. Some of the advantages of the right MMF over a bank deposit include the diversification of assets, so an investor is not beholden to the fortunes of a single counterparty and credit quality, which is higher than most banks. Treasurers therefore need to be confident in the credit rating of their chosen MMF. To provide reliable guidance to investors, leading triple A money market fund providers, such as BlackRock, have joined forces within the Institutional Money Market Fund Association (IMMFA) to offer genuine ‘treasury style’ funds. As well as meeting the stringent requirements imposed by the rating agencies, IMMFA money market funds are required to observe a Code of Practice which includes the obligation for assets to be marked-to-market regularly by an independent fund administrator.
The track record of the fund provider: Cash management requires specialist expertise and the selected manager needs to be able to demonstrate extensive experience and, above all, a solid track record in managing MMFs through full credit and interest rate cycles. Furthermore, in today’s challenging environment, investors need to be confident that their MMF manager has well-established internal credit research and risk management capabilities in order to deliver security, liquidity and consistently competitive yields. Although the rating of the fund provides some assurance of this, fund managers need to be in a position to manage the fund proactively in response to timely internal credit research.
How do money market funds compare with bank deposits?
We mentioned bank deposits earlier in the article, but as bank deposits are the most common form of cash investment, it is worth exploring this area in more detail. Many corporates maintain large amounts of cash to meet their working capital requirements. Traditionally this cash balance has been held in overnight bank deposits on the assumption that these instruments are the most secure investments that also satisfy the company’s liquidity needs. Treasury-style, triple-A rated IMMFA MMFs provide a better alternative. In particular, one of the main advantages, from a capital security perspective, is the spread of risk - with a bank deposit, an investor contracts a 100% risk exposure to a single banking name. A MMF, on the other hand, enables the diversification of this risk typically across 50-100 highly rated, short-term issuers. Furthermore, the majority of banks are rated by agencies as AA or lower whilst IMMFA MMFs are triple-A rated. Experienced and established investment managers, such as BlackRock, have extensive credit analytics and technology at their disposal, enabling them to constantly research and scrutinize the approved list of securities and therefore generally be able to pre-empt credit agency downgrades.
A further consideration which became apparent during the recent credit crisis is that when investors place their cash in a bank deposit they are effectively placing it on to the bank’s balance sheet. The most well-known example of this is the events surrounding the downfall of BCCI in 1999 when depositors discovered to their detriment that the bank was utilising funds on deposit to fund operating expenses (Source: Atkinson, Dan. ‘Accountants in BCCI net’, The Guardian, 1999-01-08). As the majority of money market funds are UCITS-compliant they are standalone entities and, as such, their assets are ring-fenced from the parent investment manager and the custodian.
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How do MMFs compare with other types of money market investment?
Investing in other money market instruments such as commercial paper brings similar issues to investing in deposits, and treasurers still need to seek assurance of the investment security and liquidity as well as yield. This requires credit research and sophisticated technology which is really only viable for treasuries with very large amounts of surplus cash, which even then is difficult to justify when MMFs supported with extensive credit research are available.
Liquidity can be an important issue as the investment needs to have the right maturity date to support the company's liquidity needs.
Liquidity can be an important issue as the investment needs to have the right maturity date to support the company’s liquidity needs. While in theory, a company can sell commercial paper if cash is required before maturity, there is no guarantee of a buyer so the company takes a liquidity risk.
Finally, MMFs offer a far more convenient solution than almost any other type of investment. Treasurers can place their funds or retrieve their cash with a single phone call, earning on their cash straightaway, without the need to select securities, or embark on time consuming back office arrangements such as working with custodians.
Conclusion
Security: IMMFA triple-A rated funds are highly secure with diversified assets, ring fencing, ratings given by reputable agencies and the support of specialist in-house credit research. In addition, there are significant advantages in terms of both liquidity and yield:
Liquidity: Using a money market fund gives the depositor the advantage of same day or next day access to their cash with the added benefit of a stable 7-day benchmarked return. Moreover, there are no investment lock-in periods, penalties or ‘break’ fees for redemptions unlike some bank deposits.
Yield: Money market funds are able to offer competitive rates of return when considered alongside bank deposits. This is of particular interest during a period of stable or falling interest rates as we are experiencing at present.
As treasurers become more risk-conscious in how they invest their cash, whilst still needing to fulfil daily liquidity requirements and deliver an above benchmark return, the growth of triple-A IMMFA money market funds is set to continue.
