Published: August 01, 2009
In the last 18 months, investor appetite for risk across Europe has fallen sharply in response to the tumultuous events in the world’s financial markets. However, one sector has experienced significant growth amidst the extraordinary market instability. Since the onset of the liquidity crisis, global money market fund (MMF) assets have risen approximately 20% to around $4.38 trillion, with European AAA-rated money market assets totaling €427.3 billion at the end of December 2008.[1] The investor base in MMFs has also expanded significantly.
As we look ahead to the remainder of 2009, we believe that MMFs will continue to attract investors. In particular, we see strong interest in those MMFs which are characterised by certain key features including an AAA-rating and a stable net asset value with a clear investment objective to maximise current income whilst preserving capital and maintaining liquidity. Within the MMF segment characterised by these key features, we see particular interest in government only funds. Whilst traditional ‘commercial paper’ money market strategies have been widely accepted by investors in Europe, there has also been a flight to safety which has led some investors to avoid all forms of corporate credit exposure. Consequently, we have seen the emergence of government MMFs. Although a recent phenomenon, these funds are now firmly established, and look set to remain an important element in many fund managers’ portfolios and investors’ cash management armoury.
Although onshore pooled government funds existed before the liquidity crisis, the offshore market for funds solely comprised of government debt was largely undeveloped. As investors became increasingly concerned about the vulnerability of the financial markets, GSAM saw significant client demand for pooled investment vehicles with MMF-like liquidity but no corporate credit exposure. This demand came initially from hedge fund managers and smaller asset managers with private wealth clients. The message we heard repeatedly was that while investors were happy in theory to accept, say, the risk inherent in a hedge fund manager’s principal strategy, any loss of cash could not be contemplated. These investors were also seeking complete transparency over the fund’s assets and were conducting greater due diligence when selecting a fund than perhaps they had in the past.
As a result of this investor sentiment, clients were starting to buy government debt directly to eliminate credit risk in their cash holdings. However, they still ran the risk that, in the event of having to sell, the price could be lower than when they purchased, thus leading to a capital loss. Indeed, such was the demand for European government debt on some occasions over the past 18 months that some corporates found it difficult to buy bills directly. Therefore, there was a need for pooled vehicles with a diversified portfolio, daily liquidity and a broad investor base to help mitigate this pressure on liquidity.
The demand for MMF-style pooled vehicles for government debt grew dramatically between late 2007 and 2008. For example, between August and October 2008, approximately $70bn flowed into government MMFs in Europe alone[2]. Not only did we see hedge fund and private wealth clients, from whom much of the original demand had come, increase the level of their investment in government funds, but other types of investor, such as corporate clients, also became aware of, and interested in them. This included companies which would not normally have invested in MMFs, but which found government debt-based pooled investments appealing. A government MMF typically invests in highly rated (tier one) government securities and supranational securities with explicit guarantees, held directly or through tri-party repurchase agreements. A typical fund will have the same credit and maturity guidelines as traditional IMMFA AAA-rated MMFs, such as a minimum credit rating of A-1/P-1 for any individual security, a maximum weighted average maturity of 60 days and a maximum maturity of any individual security of 13 months. [[[PAGE]]]
Investors select government MMFs primarily for security and liquidity purposes, with a focus more on return of capital than return on capital. However, while ‘traditional’ MMFs will generally deliver a higher return, the yield on government securities is still respectable compared with other short-term investment alternatives. Using a broad range of average performance to provide an example, government funds may be expected to deliver a return as shown in fig.1, compared with equivalent AAA-rated MMFs.
In addition to MMFs comprised exclusively of government debt, as a broad trend some other IMMFA AAA-rated MMFs have also been increasing the levels of government debt within their asset base, reducing direct exposure to asset-backed securities in particular. Such debt fits the risk profile of IMMFA AAA-rated funds, and fulfils investors’ security and liquidity requirements, while other highly rated assets enhance the yield of these funds.
Unlike other types of MMF which typically see relatively steady rises in investment levels in normal economic conditions, we expect that there will be a greater ebb and flow with government MMFs as market confidence and liquidity start to return to the market and some investors become more comfortable with traditional MMFs with a more diversified asset base. Nevertheless, we anticipate that as markets continue to recover, government MMFs will continue to have a place for low-risk investors and will also remain a very useful addition to GSAM’s fund offering, supporting a wider range of investors’ needs should more challenging economic conditions re-emerge.
As proposals for changes to MMFs take shape (see the earlier article by IMMFA entitled ‘The Future of Money Market Funds’) there may be the same kind of changes in the structure of government MMFs as other types of funds, although they are likely to remain broadly similar to their current form. One of the primary effects of any differences which we believe will be seen is the creation of more clearly-defined and segmented categories of MMFs, and which are more explicit in terms of their place in the risk spectrum. Government MMFs will remain on the far left, least risky, end of this spectrum and there will continue to be investors who specifically seek the level of security that they offer, either as their sole investment choice or as part of a wider investment strategy. Similarly, as economic conditions improve, we envisage some investors seeking funds which have greater yield differentiation and therefore are potentially further to the right of the risk spectrum. As yet, it is not clear how these funds will be constructed, but we hope that the outcome will be that investors of all types, with all types of risk appetite, will find a clearly defined, well-regulated MMF.
Notes
[1] Source: iMoneynet January 2009
[2] Source: iMoneyNet December 2008
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