Dec 2008-Jan 2009
The financial crisis has led to a greater appreciation of money market funds, and fund managers are challenging the banks as main players, writes Fiona Rintoul...
There was a time when it was possible to see money market funds as commoditised products best chosen according to which had the lowest total expense ratio (TER). The rationale behind the choose-by-TER theory was that the lower the TER, the less the provider had to stretch to offer a higher yield.
“Historically, as the market moved into today’s toughened situation, there was a heightened focus by institutional investors into money market funds on yield,” explains Mark Stockley, global head of cash and liquidity sales at Barclays Global Investors (BGI). “As there wasn’t much difference in return between top-quartile and bottom-quartile funds, those investors who were very yield-driven focused on the expense ratio.”
Those times are most definitely gone, however. In today’s world, investors in money market funds don’t care that much about yield. In the current environment, Mark Camp, director of institutional liquidity funds at Henderson Global Investors, says: “After security, liquidity is the next important factor, perhaps more important. Then comes performance and fees are part of that.”
Camp even suggests that there may be a little upward pressure on fees as clients come to understand that security and liquidity are not givens. Helped by events such as the Icelandic savings bank debacle, there is now a clearer understanding in the market of what can happen when things go wrong and a greater appreciation of the job done by money market fund managers and the risks taken.
“We haven’t seen providers putting fees up, but we have heard of other fund groups taking a tougher stance on fees, certainly in terms of discounting,” says Camp. “I’m certainly being tougher on fees. I will discount, but I’ll require greater commitment in return.”
Indeed, it can be a case of ‘needs must’. Those who aren’t tough on fees may end up paying the ultimate price. “Some very low-cost providers are gone,” remarks Stockley.
Importance of relationships
Low-cost providers can fold because clients who were lured in by bargain-basement fees don’t stick around when the going gets tough. “Those that have used low expense ratios to buy distribution find that the stickiness isn’t there in the client relationship,” says Stockley. “If a client only buys based on return and price and doesn’t have a relationship with the provider, they will be the first to leave when things get tight and challenging.”
Or companies can choose to exit the business because running successful money market funds in the current climate is really rather difficult and not particularly lucrative.
“From the fund promoter’s point of view, there’s been a lot of questioning as to the economies of the product,” says Camp. “One particular large provider could be giving up this space.”
Clients have also become more choosey when selecting fund promoters, particularly when it comes to size, and smaller firms may find themselves deselected. This is partly for the same reason that Icelandic banks have been deselected: the backer is not big enough to engineer bail-out.
“The market has become much more sensitive to the size of the sponsor,” says Marc Doman, managing director of Invesco Aim. “Clients want to know if you are a large company and if you would make good your money market funds if necessary.”
There is, of course, the salutary example of Reserve Management Corporation, an independent company not backed by a large parent, whose Reserve Primary Fund ‘broke the buck’ (saw its NAV drop below $1) in September 2008 after suffering losses related to the Lehman Brothers collapse. The New York-based firm now faces law suits from disenchanted clients.
At the same time, even large companies may feel they don’t want to bail out money market funds, particularly if they have a diversified business and money market funds aren’t a strong focus.
“It will be interesting to see who comes out of the business,” says Doman. “If companies have to support funds with costly injections of cash, will they get out and transfer the liability to someone else? We’ve seen that with Aviva.”
Aviva Investors amended the terms for two of its money market funds in November 2008, changing them from constant NAV funds to variable NAV funds. At the time, Richard Warne, head of institutional distribution at Aviva Investors, denied the move was taken because the funds were about to break the buck.
Against this backdrop of uncertainty, it’s no wonder there’s a hunger for security. Figures from iMoneyNet, a US-based information provider, bear out this trend. Its figures show the split between Treasury funds and other stable-NAV cash funds changing through 2008 with investors favouring Treasury funds. While Treasury funds accounted for around 20% of the total stable-NAV cash fund universe at the beginning of 2008, by October 2008 that figure had risen to 40%.
The iMoneyNet figures are for the US only, but there is a similar flight to safety in Europe. “Clients are moving down the risk spectrum,” says Stockley.
Change of focus
This new focus on security and liquidity is changing the money market fund universe in Europe and beyond. For a start, some in the market believe money market funds (US-style) will be more minutely differentiated in the future. Robin Creswell, managing principal at Payden & Rygel Global in London, says current market conditions mean the traditional twin objectives of money market funds – to beat Libor or bank account returns, and to deliver this with a stable NAV – are now mutually exclusive.
Only funds that invest exclusively in government paper can be certain of maintaining their NAV, he insists, but that paper will yield less than Libor. To achieve a higher yield, funds would have to go after corporate paper, which could impact their NAV.
“Money market funds that are still trying to achieve the old objectives rely on using a broad spread of paper and they rely on customer flows matching or increasing, because if you have to sell the paper it’s difficult to know if you will be able to sell without taking a discount,” says Creswell.
“In the future, the disclosure and analysis of money market funds will have to be more explicit,” he continues. “It’s fine to launch a triple A-rated money market and to have it using non-government paper, and for it to be liquid and have a stable NAV, but you can’t guarantee those last two legs of the stool.”
This may appear quite a stringent view, but Creswell’s basic point is a good one: investors should know exactly what they are buying.
Another consequence of the new focus on security and liquidity within Europe is that the old arguments about which model was the right one – either the US-style money market fund model with a constant NAV and triple A-rated, or the French-style model with a variable NAV and triple A rating not obligatory – have been quashed. The truth is that neither is right or wrong; they are different products that do different things. The former should be cash-equivalent, while the latter is an investment product with the attendant heightened risks that term implies.
But some of the arguments made by providers of the French-style funds in the past would certainly ring rather hollow today. In the current climate, no one would argue, as some providers of French-style money market funds once did, that the additional security in terms of capital preservation provided by constant-NAV funds is only for the exceptionally neurotic.
“When this whole crisis started Europe was a backwater for our type of product,” says Doman. “Triple A didn’t mean anything. Constant NAV didn’t mean anything. Now there’s much greater interest from mainland European countries in triple A-rated funds and that interest will only grow.”
As if to underline this the Institutional Money Market Funds Association recently recruited its first mainland European member in the shape of Société Générale.
So what does the future hold for money market funds in Europe?
With banks discredited, there’s clearly room for the US-style funds to expand their business as a bank diversifier. Henderson’s Camp suggests that companies that are neither extremely large where they can run their own Treasury departments, or extremely small where banks are still a sensible first port of call, will increasingly place their working cash in constant-NAV money market funds.
It’s also possible that banks themselves will become big clients of money market funds. Increased capital requirements from Basel II could make deposit taking more expensive for banks, says Doman. Money market funds, which take the cash off the balance sheet, could be the answer. This in turn, “could be the kicker that starts bringing money market funds into the retail sector”.
But although there may be more business out there, business conditions are also likely to be tougher. Nowadays, companies that want to thrive in this sector need to make a substantial investment in infrastructure and research. Proprietary credit research, for example, is a must. Only the strong and committed are likely to survive – or even to want to stay in the business – and size will definitely be a factor.
At the same time, interest rates are low and falling further, and, although there may be some increased willingness in the market to pay for capital preservation and liquidity, it’s not going to be that easy to turn a decent dime.
However, Henderson’s Camp has one salutary thought in that regard. He believes US interest rates will not come down to zero precisely because that would make money market funds uneconomic, as is already the case in Japan.
“Nearly 40% of free cash in the US is in money market funds,” says Camp. “There isn’t enough capital in US banks to take that up. They need the money market funds.”
©2008 Funds Europe