Through the Glass Darkly: Transparency Can Be a Dangerous Illusion

by Justin Meadows, Chief Executive Officer, MyTreasury

Before the collapse of Lehman Brothers in September 2008 some of the more sophisticated institutional investors took an interest in the portfolio holdings of their money market funds (MMFs) and reviewed these with varying degrees of care whenever they were disclosed. In some cases this was just a tick-box exercise to tell senior management that they were aware of the funds’ holdings, while in other cases there was genuine scrutiny. Many other investors took the view that the reason they used MMFs rather than pursuing their own distributed investment strategies was because they did not have the in-house credit research expertise to do a better job than their fund providers. The collapse of Lehmans changed all this and many institutional investors went from just paying funds a management fee for their credit research expertise to both paying them and policing them to ensure the required level of comfort in the fund holdings.

This increased interest has arisen not just because of credit quality issues but also because since the crisis institutional investors have typically been operating under wider and more tightly defined treasury policies including exposure to particular counterparties, asset types and countries as well as credit quality. For this reason it is easy to see why there has been a heightened interest in the scrutiny of portfolio holdings. As the experience of investors has grown in this area it’s not surprising that so have their requirements. Rather than just looking at the holdings of their individual funds they want to look at holdings across all their funds to see whether there is any risk concentration, for example as a result of their funds being invested in the same securities or ones issued by the same counterparties or of the same asset type or from the same country. In some cases investors then want to link this information back to their exposure across all money market instruments to get an overall picture of their credit position, but there are not many who are in a position to be able to do this – yet!

In response to these emerging demands some MMF portals have developed functionality to deliver cross-portfolio analysis of fund holdings. However, while at first sight it may appear attractive to have pretty-coloured bar charts and pie charts providing all kinds of portfolio analysis, there are some fundamental flaws in the ability of the portals to provide meaningful information and these need to be clearly recognised if investors are to avoid making poorly informed and hence potentially wrong investment decisions.

Not all funds can provide the full data-set required to allow portals to produce a consistent analysis. This is particularly important where the funds don’t provide unique securities identifiers such as CUSIPs or even ISINs, which contrary to popular opinion aren’t actually unique anyway! This means portals are forced to look at the names of the securities and, where they appear similar, take a view on whether they are actually the same security. This obviously opens up the possibility of significant errors being made. Some data items such as country, credit rating, maturity and asset type are frequently missing or reported differently by different funds for the same security, leading to an incomplete or inconsistent analysis.

The funds provide their portfolio holdings information with significantly different frequencies. Some funds provide them every day, some every week or every two weeks and some only monthly, in some cases with an additional two-week delay built in. This means that the data being compared is far from homogeneous, which gives rise to significant distortions due to its inconsistent timeliness. [[[PAGE]]]

Any analysis based on inconsistent and out of date information is at best worthless and at worst positively dangerous.

Even if it were possible to get the full range of uniquely identified securities data with consistent timeliness, there is still the problem that the liquidity requirements of funds means that at least 10% and possibly up to 20% of a fund’s portfolio will only have been held overnight, and between 30% and 50% will have been held for a maximum of a week. So even when a fund releases portfolio holdings data in a timely way it will be substantially out of date for a significant proportion of the portfolio. This of course is an issue even with single fund analysis, but the problem is compounded when the data is being used for cross-fund analysis.

The simple reality is that any analysis based on inconsistent and out of date information is at best worthless and at worst positively dangerous. For this reason one of the portals, MyTreasury, is taking a responsible approach and has contacted the IMMFA funds to secure industry support for the development of a standardised portfolio holdings minimum data-set to be provided by all fund providers with an agreed frequency. This initiative is currently being discussed within IMFFA. At the same time the MyTreasury User Group is undertaking a review of investor portfolio holdings data requirements to be provided to the IMMFA funds to help define the agreed data-set across all the key players in the industry. Only when this has been completed will MyTreasury feel comfortable in rolling out the portfolio analysis product it developed over a year ago as a safe and useful tool for investors. In the meantime there is no safe substitute for asking the fund managers directly about investment strategy generally and portfolio holdings specifically.