Published: November 01, 2009
This month brings Remembrance Day when we think back to the victims of war over the past century. Many war memorials are engraved “Lest we forget”. Today’s conflicts in so many parts of the world suggest that we have indeed forgotten the tragedy of warfare. But as many parts of the world now start to pull out of financial crisis, are we also in danger of forgetting the lessons that we have learnt? The financial markets are returning to confidence and liquidity and some investors are starting to cast their eyes around for greater yield opportunities. For corporate investors, the past year has seen major changes, with money market funds (MMFs) proving a steadfast and reliable means of investing cash while satisfying the company’s security and liquidity objectives. Looking ahead, proposed regulation should make it easier for investors to identify the MMFs that meet their investment objectives.
MMFs remain an important investment vehicle, but investors are seeking the more balanced investment portfolio that prime funds represent.
Commentators often cite the growth in assets held in MMFs over the past year almost as a validation of their quality and suitability for corporate investors. This view tends to ignore the initial reaction to the Reserve Fund ‘breaking the buck’, which was to move away from MMFs, particularly in the United States, although confidence returned quite quickly. The growth of government funds (i.e., MMFs exclusively comprised of government debt) immediately following the crisis has been described as a ’flight to quality’ amongst investors as they sought investments with the lowest possible risk as the crisis shook the markets.
Duncan Thomson, Investment Director, Scottish Widows Investment Partnership summarises some of the motivation for changes in investor behaviour over the past year,
“We have seen a variety of changes this year which have influenced the flow of cash both into and out of MMFs. Investors have invested more in MMFs as they became more concerned about riskier assets. Others recognised that they did not have the necessary skills, time or resources to manage assets themselves, and therefore looked to pooled, outsourced investment vehicles such as MMFs. Furthermore, although investment yield has been a minor consideration during the crisis, MMF yields have compared well compared with those available on short-term investments such as deposits.
Conversely, some investors have developed a negative perception of MMFs since the collapse of the Reserve Fund in the United States, and have preferred to invest cash directly into government-guaranteed banks.”
David Rothon, Fixed Income Product Specialist, Northern Trust continues,
“Use of MMFs has increased amongst corporate treasurers for a number of reasons. As banks’ credit ratings have been downgraded, there are fewer possible investment counterparties for companies whose investment policy stipulates an ‘AA’ issuer rating, for example. There is also pressure on treasurers to demonstrate a high level of due diligence in their investment decisions. MMF providers have far greater access to credit analysis tools and resources than an individual treasury department, so it makes sense for treasurers to outsource their cash investment and use MMFs.”
Although IMMFA AAA-rated funds have grown by nearly 7% during the first three quarters of 2009 (iMoneyNet) this does not reflect the differences between funds. Using data provided by iMoneyNet, we can see some interesting trends over the period from 31 December 2008 to 30 September 2009.
USD funds remain the largest, with over $280,000m in assets under management at end September 2009, but this reflects a fall of nearly 8% since end 2008. This is not to say that MMFs per se are proving less attractive to investors, however. While the first quarter saw a continuation of the fall in assets that started in 2008, the third quarter saw gross inflows into USD funds. The statistics for USD funds are influenced strongly by government funds (i.e., funds solely comprising government debt), which emerged strongly in 2008, but assets in these funds fell by nearly 45% during the first three quarters of 2009 while assets in prime (or regular) USD-denominated funds actually increased by 11% over the same period. These statistics perhaps indicate that the ‘flight to quality’ has halted, and investors are returning to normal investment behaviour. MMFs remain an important investment vehicle, but investors are seeking the more balanced investment portfolio that prime funds represent. Security and liquidity remain vital considerations, but investors are not willing to give up opportunities to earn a yield on their cash that is comparable with deposits.[[[PAGE]]]
GBP-denominated funds grew by 6.3% during the first three quarters, reflecting strong growth in the first two quarters and only slight growth during the third quarter. GBP funds were less affected by a loss of market confidence than USD funds, reflected in a reasonably steady growth in the number and type of investors seeking MMFs, and the proportion of their surplus cash that investors in MMFs place into these instruments.
EUR-denominated funds are the rising stars of the MMF world, with growth of over 26% in assets under management between January and September 2009. This growth is similar for both prime and government funds, reflecting a very different trend from USD funds. Travis Barker, Chairman of IMMFA (Institutional Money Market Funds Association) explains,
“One phenomenon since the crisis has been the growth of euro-denominated MMFs in particular. We are seeing greater adoption of MMFs amongst European treasurers, while in the past, these were more common amongst UK and US treasurers.”
He continues,
“It usually requires a rupture of some sort to act as a catalyst for a change in behaviour. This has particularly been the case in countries where there have been incidences of banking failure, since these failures have led to treasurers seeking alternative cash investment opportunities.
“There are a variety of reasons for the growth of [EUR] MMFs but the crisis reminded treasurers that counterparty is a very real, as opposed to theoretical risk. This has resulted in treasurers moving away from a ‘house bank’ model and seeking greater diversification.”
Not only have a larger number of investors sought to invest in MMFs, including corporate treasurers, but investors’ demands of MMFs have changed too, as David Rothon, Northern Trust outlines,
“Treasurers are scrutinising potential MMFs in far more detail than we have seen in the past. For example, even a company investing in AAA-rated government funds may still need assurances about the rating of each individual holding. Two or three years ago, treasurers would not have been concerned about a MMF portfolio comprising asset-backed commercial paper (ABCP); now they seek specific commitments that a fund will not include ABCP. All investors are seeking a higher level of visibility into MMFs, including exposures, holdings, approach to liquidity, duration and maturity of assets and the quality of the credit process.”
Greater demands from investors have led some asset managers to make some changes to their business, not necessarily in the way that they manage their funds, but in the way that they communicate with investors. Duncan Thomson, Scottish Widows Investment Partnership explains,
“Scottish Widows Investment Partnership has introduced some minor changes to the way that they manage their MMFs since the crisis, in response to increasing demand for information from investors, but these changes have not needed to be material as we already manage our funds in a risk-averse way. For example, we now provide full portfolio disclosure whereas in the past, everything maturing within seven days was included in a single bucket. This gives investors full transparency over the assets within the portfolio so they can perform their own due diligence as necessary. We have also made some minor changes to our credit criteria although we have not needed to adjust our overall credit processes.”
So if investors have looked more to MMFs to satisfy their investment objectives of security and liquidity, are corporate treasurers amongst those starting to look for higher returns? Duncan Thomson, Scottish Widows Investment Partnership, argues that yield is still a secondary objective,
“Investors have historically sought to maximise yield from their investments. Liquidity was not really a primary issue, as access to liquidity was assumed rather than a defined objective. Today, capital preservation and liquidity are paramount, with yield more of an investment by-product.”
David Rothon, Northern Trust, concurs,
“In many cases, treasurers’ cash investment objectives in the past were to maximise yield. Today, the primary objective is return of capital rather than return on capital; consequently, security and liquidity concerns are paramount.”
MMFs have fared well during the crisis, resulting in new groups of investors seeking to benefit from their diversification and credit quality.
The move away from USD government funds, however, suggests that investors are not prepared to sacrifice yield entirely, as long as their security and liquidity objectives are met. In a low interest environment, yield is likely to be a lower priority, but as interest rates rise in the future, it will be important that corporate investors keep their corporate objectives in sight and do not chase yield to the detriment of security of capital and liquidity.
One of the challenges for corporate treasurers seeking pooled investment funds that satisfy their security and liquidity objectives is how to distinguish between the range of different funds that are available, with differences in the use of terminology and presentation. The crisis has acted as a catalyst for industry bodies to promote greater clarity and standardisation within the industry. Regular readers of TMI will remember the article in last month’s edition from Mark Allen of Goldman Sachs Asset Management in which he summarises some of the proposed regulatory changes outlined by EFAMA/IMMFA, which are shown again in figure 1 for convenience. [[[PAGE]]]
By distinguishing between ‘short-term’ and ‘regular’ MMFs (although both are designed as tools to help investors support their cash and liquidity management requirements) and clearly outlining the characteristics of each, corporate treasurers should find it easier not only to select the fund that best meets their investment objectives, but also to explain their fund choice to senior management. The proposed regulations have largely been supported by the MMF community. Travis Barker, Chairman of IMMFA explains,
“One of the benefits of the proposed regulation is that providers will speak with one voice rather than using their own language and presentation, which can be confusing for investors; instead, the MMF designation will act as a type of ‘kite mark’, giving greater reassurance to investors.
“From a provider’s point of view, regulation is positive as it ensures that there are minimum industry standards in place with each firm competing equally and avoids the risk of reputational damage should one firm not adhere to the same standards as others.”
Duncan Thomson, Scottish Widows Investment Partnership, adds his cautious approval,
“We are largely in favour of the EFAMA/IMMFA proposals. The MMFs industry is already strong and we welcome means of strengthening it further. However, with a number of interested parties, it will be difficult to define a product that satisfies such a wide variety of different objectives. It will also be important not to over-regulate as a reaction to the crisis, resulting in a product that is too inflexible.”
David Rothon, Northern Trust continues,
“What will be most important is how MMFs are labelled and what they look like. So many funds that are sold as MMFs are actually short duration bond funds, so new regulations should help to reduce this ambiguity.”
MMFs have fared well during the crisis, resulting in new groups of investors seeking to benefit from the diversification and credit quality of these instruments. Furthermore, although EUR-denominated funds have shown the most significant growth, interest in MMFs is not a phenomenon restricted to Europe, as Travis Barker, IMMFA, explains,
“Adoption of MMFs seems to have reached a tipping point, not just in Europe, but in Asia too. To address this, IMMFA has created an Asian subcommittee to recognise the need for MMFs in the region.”
Travis goes on to outline how MMFs could develop in the future, 
“Looking ahead, the core objectives of MMFs, namely capital security and same day liquidity, have been validated by the crisis and will continue as such. Furthermore, the ‘headline’ of IMMFA’s proposed revised Code of Practice, which is the requirement for minimum liquidity both overnight and one week, cements the second of these objectives even further.”
Duncan Thomson, Scottish Widows Investment Partnership, agrees that new regulation will be an important driver in the development of the MMF industry:
“Looking ahead to a year from now, regulation will undoubtedly be stricter, some aspects of which may be positive, some less so. We see investors remaining conservative in their outlook, but yield is likely to become a more important factor in their investment decisions. While we are likely to continue to see growth in the number of investors using MMFs, if the economy recovers companies are likely to want to return cash to shareholders and/or invest in the business, resulting in lower levels of surplus cash to invest.”
While regulation should bring new clarity for investors, it will be important that treasurers take advantage of this standardisation, and do not forget the lessons learnt over the past year.
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