Risk Management in the Money Markets

Are all cash funds created equal?

by Alexander de Giorgio, CFA, Product Manager, Fixed Income, and David Rothon, Portfolio Manager, Northern Trust

Before the events of August 2007, money market funds were generally perceived to be at the safer end of the risk / reward spectrum. Numerous products exist where traditional benefits are to provide capital preservation, high levels of liquidity and then to maximise the yield. For investors with differing risk appetites, the choice of strategy was ample and included everything from stable NAV money market funds to enhanced cash funds and short term bond funds. All were backed by high credit ratings and promised to add minimal risk to an overall asset allocation.

Recent distress in the financial markets has been widespread and the spotlight was focused on money market funds when concerns were raised over the degree of principal protection inherent in funds. The realisation that all money market funds are not the same has highlighted the importance of understanding the risk / return dynamics of differing types of money market funds.

How did we get here?

By taking a step back to understand how the money market universe has developed over the last decade it can be seen that ongoing regulatory changes in the US and Europe, as well as the increasing complexity of corporate cash management, have fuelled a dramatic growth in assets under management in the industry. Money market funds offered an attractive alternative to traditional bank deposits, providing diversification, off balance sheet exposure and access to active investment strategies without sacrificing liquidity.

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