May 2008


The shift into money market funds will not end when the credit crunch lifts. It is part of a long-term trend, writes Fiona Rintoul ...
Investors have been piling into money market funds like they’re going out of style. In January, European investors moved a whopping e82bn into the products, while in February the figure was e27bn, according to estimated net sales figures from Lipper Feri.

There are always strong flows into money market funds in January, but the 2008 figures were exceptional. In 2007, meanwhile, inflows to money market funds were all that stood between the European fund industry and a rout.

“2007 will go down in asset management history as its worst year on record, beating even 2002 for this dubious accolade,” wrote Lipper Feri in a year-end summation of the sub-prime damage. “If it had not been for the positive injection of cash into institutional liquidity products, Europe’s net sales total would have been a deep shade of red (-60bn).”

Yet at the same time money market funds are, in fact, going out of style – or at least some of them are. Problems with so-called enhanced cash funds have left a question mark over these products that some feel will be a long time in  disappearing.

“It’s hard to see them coming back anytime soon,” says Diana Mackay, CEO of Lipper Feri.
There have certainly been some fishy goings-on. In Germany, reports Rudolf Siebel from the BVI, the German trade association, there were net inflows of e5.4bn to money market funds in the first quarter of 2008. However, the performance of a number of funds was poor, and in some cases negative, something that clients certainly would not accept from a bank deposit account. 

Defining the problem
At the same time, money market funds are being extolled as the safest way to invest liquidity in the credit crunch. What’s going on?

The problem, really, is one of definition. “The term ‘money funds’ does cover a multitude of similar type products,” says Kevin Thompson, managing director of Fidelity’s Institutional Cash Fund plc. “The press in particular use the term quite liberally.”

But there is a world of difference, promoters argue, between the US-style triple A-rated, constant NAV money market funds, often called treasury funds, and the French-style funds, which are really more short-term bond funds. It’s a difference that has come home to roost during the credit crunch with some of the latter type of funds having to close.

This has created a changed dynamic in the market, with new customers coming to treasury funds, often from markets where they were previously pooh-poohed, such as France.

“There’s been a big realignment in France,” says Mark Camp of Henderson Global Investors. “It used to be very difficult to persuade them to listen to your pitch and argument. Now quite a lot of them are trying to convert their funds closer to treasury-style funds.”

It’s all been hugely to the benefit of treasury funds. Figures from the Institutional Money Market Funds Association (IMMFA) show funds under management in Europe for IMMFA members reaching almost €400bn at the end of 2007, a 50% increase from the same time the previous year.

“These record funds-under-management figures confirm the growing popularity of triple-A rated money market funds which is in marked contrast to other mutual funds, which have generally seen outflows over the past few months,” commented Donald Aiken, chairman of IMMFA during a speech at the association’s AGM in April. “There is something about this product that investors like, which I believe is the liquidity aspect.”

Aiken also emphasised the funds’ safe-as-houses credentials. “The current market turmoil has proven, beyond any shadow of a doubt, the strong liquidity characteristics that are inherent in this type of product,” he said. “There can surely be no better stress-test or reality check for a product’s credentials than the global market turmoil we are experiencing.”

It’s certainly easy to see the appeal of treasury funds’ combination of liquidity and safety at the moment. But what about when things improve? In the past, the funds have been almost derided by advocates of less restrictive, higher-yielding funds for being excessively safe. That’s obviously not a popular position right now, but won’t they lose their appeal when the current market turmoil comes to an end? Won’t people turn back to other investments?

Their proponents don’t think so.

Money that is ‘parked’ in money market funds obviously will be reinvested in other vehicles at some point. But there are other factors at play - some regulatory, some to do with the sobering nature of the current crisis - that make promoters of treasury funds believe they have a booming long-term future.

“This current environment can be allied to what happened in the US where money market funds were born out of the savings and loan crisis,” says Marc Doman, managing director of Invesco AIM Global Cash Management. “What the Savings and Loans crisis did for money market funds in the US, the credit crunch will do for money market funds globally.”

There’s always risk
The first thing the credit crunch has done is to highlight that there is risk in everything, kyboshing once and for all perhaps the notion that an enhanced cash fund can provide extra return for no additional risk – or for an additional risk so minimal as to be negligible.

“Before risk was priced out of the equation,” says Doman. “Now it’s priced in. Risk is related to reward and to liquidity. Enhanced cash products will return because greed will always return, but they will be seen now as risk investments rather than no-risk investments.”

The other key driver of growth is regulatory change. At the national, European and international level, regulators are playing the kind  of tunes that promoters of triple-A rated money market funds want to hear, making it easier for pension funds, corporates and banks to use them to manage their liquidity 

Chris Oulton set up Prime Rate, a specialist independent wholesale money market fund provider, in May last year in anticipation of the new demand these changes would bring.

“I could see there were huge regulatory changes coming that would facilitate new people coming into the market,” he says. “There were going to be new buyers in the market looking 
for product.”

In some cases, these new buyers might not be in a position to run their own money market funds, but might also prefer not to buy from a competitor, for example in the case of banks. Oulton therefore saw a niche for an independent specialist provider.

What he hadn’t foreseen was the credit crunch, which in many ways came at the best possible time for him. The credit crunch effectively encouraged investors who might have been thinking about moving their liquid assets from bank deposits to money market funds further to regulatory changes to get on and do it.

“There couldn’t have been a better wake-up call than the credit crunch we’ve just been through,” says Oulton.

This kind of money is sticky because it isn’t the result of a flight to safety, but of product substitution. “A lot of people are going into money market funds permanently,” says Doman. 

Further expansion
There is more expansion to come. The industry is currently lobbying, inter alia, for clearing banks to be allowed to use money market funds and for money market funds to be made ‘repo-able’.

“Banks carry a lot of liquidity and could potentially be very big investors in these funds,” says Jonathan Curry of Barclays Global Investors (BGI). “That creates its own challenges in terms of managing those assets, so we’re looking at whether money market funds can be made ‘repo-able’ to help them manage money for banks.” 

This is important because it’s for large-scale investors such as banks and endowment funds that money market funds are the most valuable, Doman suggests. “The real value is at the large end,” he says. “If you have $1bn to invest, you have a real problem because there aren’t enough high-quality banks around.  In this environment depositors fear banks. Even banks fear banks.”

If the credit crunch has thrust these triple A-rated funds, that might once perhaps have been perceived as boring, into the limelight, it has also brought them under closer scrutiny from clients. “Clients are demanding much greater transparency in terms of the process,” says Thompson. “They are buying money market funds the way they would an equity fund.”

This has led to greater differentiation among the funds. “A few years ago the market saw them as a commodity and fees were the only differentiator,” says Thompson. “That’s changed and people now recognise this isn’t a commodity. They need to understand the investment in capabilities a firm has made in support of its money market business.”

This means fees are less of an issue than they were in the past, with people realising that “there is a price for credit”. It also means differences of opinion occur.

Thus, Oulton holds no asset-backed securities in his funds because “that’s where the problems started”, but Doman disputes the blanket dismal of asset-backed paper.

Asset-backed has become a negative term because the sub-prime horror grew out of asset-backed securities, he comments. But that was particularly mortgage-backed securities, and it doesn’t mean that all asset-backed paper is bad. It kind of depends what the backing assets are.

“We are still strong supporters of asset-backed commercial paper,” Doman says, “but we only buy structures which have 100% liquidity.”

Bright future
Whatever the precise underlying construction of the funds, it’s hard to see anything other than a bright future for triple-A rated funds. As Thompson says, “they are a product whose time has come”.

For other types of money market funds, the future is less certain. What seems likely is that they will be more clearly differentiated from triple-A rated funds. CESR, the committee of European securities regulators, has already moved in this direction and Siebel says that Efama, the European asset management trade body, is also leading discussions on product differentiation.

In that case, there may be a broad acceptance of funds that perform will. “There is scope for enhanced cash funds,” says Oulton. “But they’re there to do different things from triple A-rated funds. Where you have a problem is where one masquerades as the other.”
© 2008 funds europe 

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