Published: November 01, 2013
With the short-term investment landscape rapidly changing due to a number of factors, attitudes around cash investment strategies are also evolving. Money Market Funds (MMFs) are, and will continue to be, important cash investment vehicles for a wide range of investors; however, the low yield environment and the changes brought on by regulatory debate have shifted the money market fund landscape. Investors need to embrace and understand these changes but also be aware of alternative options that are available and may be better solutions for some or all of their cash management needs.
In this article we aim to address the solutions that are available to investors in the short-term fixed income space and clarify how they can be used effectively to manage every individual investor’s unique requirements in these challenging times.
A. Acceptance of share reduction mechanisms
As has been the case for some time now, trading conditions in money markets remain challenging and recently money market instrument yields have traded negatively. In these highly unusual circumstances, fund providers, recognising that investors accrue considerable value from the availability of share classes with a stable NAV, have determined that it is in the best interests of shareholders to implement a form of a share-reduction mechanism which enables a stable NAV to be maintained on days when the net yield on the fund is negative.
The mechanism works as follows: On days where there is a positive net yield, dividends will be accrued normally; however, on days where the net yield is negative a number of shares with a NAV which equals the amount required to maintain a stable NAV per share may be redeemed. The redeemed shares will be cancelled and the value attributable to those shares will be retained by the fund provider to offset the net negative yield. This will enable the NAV per share to remain stable. Therefore, shareholders would incur a reduction in the number of shares they hold.
B. Unrated money market funds
Unrated MMFs provide an investor with the option to invest in a portfolio of the same high quality assets that are held in an externally rated MMF just without the constraints of credit rating agency guidelines. For example, the same high quality names that cash investors are used to seeing may be invested in but with slightly longer durations or in slightly high concentrations. This provides the client with the potential for a yield pick-up over funds that have an external rating.
Credit analysis and review is not absent in unrated funds: unrated refers to the rating applied at the fund level, which analyses the adherence to specific guidelines established for rated MMFs. At BlackRock we consider external ratings as a preliminary screen in our own independent credit review; that is, we use the ratings as a ‘starting point’ in our assessment of an investment, formulating our own independent ‘credit opinion’ about an issuer or a specific investment instrument. Our assessment does not end when we purchase a security. Just as each rating agency may upgrade or downgrade issues, our credit analysts apply an independent assessment of each security throughout the period that we hold the security in a portfolio which includes monitoring rating agency changes.
Over 45 credit analysts oversee BlackRock’s money market approved lists and all investments considered for our rated and unrated funds must be on these lists. Over the past ten years the BlackRock credit team has anticipated ratings downgrades, and withdrawn securities from the approved list or restricted the maturities of these issuers, an average of eight months ahead of the rating agencies.
C. Short bond fund alternatives
As part of the European Securities and Markets Authority (ESMA) guidelines there are ‘short-term’ money market funds that are the most commonly known but they have also defined a set of guidelines for money market funds with a slightly longer duration.
Features of these funds typically include:
These funds also have the potential for a yield uplift compared to short-term MMFs and often have a total return objective.
When considering longer-duration funds, the concept of cash segmentation is making a reappearance as these funds are ideal for cash considered ‘strategic’ that can be invested for a longer period of time. It is important for cash investors to conduct a thorough evaluation of their cash needs and pinpoint their risk profile. Effective forecasting of liquidity needs and assessment of risk tolerance allows for the best opportunity to achieve excess returns within a cash portfolio and to quantify how much cash is available for strategic investment in these types of funds.[[[PAGE]]]
D. Separately managed accounts (SMAs)
Separate account strategies also represent a unique way to achieve investment objectives for all types of cash – working, core and strategic. An institutional separate account is a segregated portfolio of short-duration assets managed by an investment manager on behalf of a company. A separate account differs from a money market fund in that the investor directly owns the portfolio of assets rather than owning a share in a pool of assets. The separate account investor can customise the portfolio to their liquidity needs and investment guidelines while leveraging the trading, portfolio management and credit analysis of an outside investment manager.
Separate accounts are appealing to investors for a number of reasons, one being the ability to obtain extra yield over that of a money market fund. As discussed previously, the current interest rate environment translates into extremely low yields on cash investments leading many investors to look to separate accounts in order to create a portfolio that can produce a higher yield but without a significant increase in risk.
Clearly, preparation and flexibility are key in these challenging times. However, the principles of security and liquidity should never be compromised at the expense of yield. While a turnaround in rates is dependent on a number of factors — e.g., the government’s stimulus package, budget deficits, economic weakness/strength, and consumer confidence levels — current conditions support our view that low interest rates are likely to remain for a while and, consequently, to thrive in this challenging environment, the fittest investors will be more nimble in their approach, more adaptive in their thinking, and more flexible in their search for opportunities.
If you are concerned about the challenges ahead you are not alone. In a survey conducted by BlackRock it was found that 90% of clients surveyed would need to amend their investment policy to implement any of the alternatives mentioned above and are not prepared for change.
For cash investors, the past few years have seemed like a fight for survival. But there are ways to adapt to the new world, to make the shift from survival to revival.
We continue to focus on the fundamentals of capital preservation and liquidity as the overarching objectives of risk managed cash investing. We consistently apply rigorous credit and risk analysis in our approach. This focus has enabled us to weather market volatile and remains unwavering today. Notably, recent events have not inspired a re-evaluation of our methods for managing this vital asset class; rather, they have reinforced our commitment to the approach we have employed for more than 40 years. The markets may change, as may our tactics or strategies, but our core values will not.
At BlackRock, we believe that no matter how tumultuous change is, it also brings opportunity for investors with the determination to seek it out and the confidence to act. Success in today’s markets requires strong partnerships, more flexible and dynamic strategic cash allocations, enhanced governance and, above all, a comprehensive understanding of risks and opportunities. It’s why we have embraced a new standard of analytical rigor and fact-based investing. In vast quantities of information, we seek the insights that can change outcomes.
It’s why we have built our capabilities around our clients’ greatest needs. And our cash management business strives to deliver those investment capabilities in a way that we believe only BlackRock can – leveraging the insight of our colleagues across asset classes and geographies. It’s why we are called in by companies, governments and investors all around the world, in crisis after crisis, to bring clarity to their most daunting financial challenges.
Providing answers has been our commitment to clients since we began. And in a world that grows ever more complex, it’s a responsibility that has never been more important.
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