Redeeming qualities make up for a lack of glamour

Simon Hildrey constructs a picture of an asset class whose standard feature is its same-day liquidity. But it is the quality of credit research that will help potential investors differentiate between the 30 major providers in Europe. Money market funds may not carry the mystique of hedge funds or the excitement of equity funds but they are becoming increasingly important to both investors and asset management groups. This is reflected in a near 25 per cent increase in assets under management of “offshore” money market funds in Luxembourg, Dublin and the Channel Islands in the last three months of 2002, to $130bn (€118bn). Despite the growth of the industry from under $1bn in 1995, there has been no reduction in the volatility of inflows into and redemptions from money market funds. Money market funds are collective investments that invest in short-term debt instruments. They offer the benefits of diversification and economies of scale, reducing costs and charges. Their advantage over bank deposits is that they offer daily trading, allowing investors to redeem money without suffering a penalty charge or loss of interest. Unlike high-interest bank accounts, money market funds do not require prior notice for withdrawals. Two types of funds There are two main types of money market funds:

• Constant net asset value;
• Accumulating net asset value. In the former, investors receive income on a daily basis. This can be paid out to the investor or used to buy more units in the fund. In accumulating net asset value – or roll-up – funds, income is not distributed but the value of the fund shares increases accordingly. It is also possible to invest in so-called enhanced cash funds, some of which are not AAA rated. These funds aim to generate a higher return by investing in longer dated paper or by going lower down the credit rating spectrum. Standardisation Investors have plenty of asset management groups from which to choose when deciding on a money market fund to invest in. But Catherine Barker, product manager of the European cash team at Barclays Global Investors, says there is a large degree of standardisation among money market funds. Indeed, providers in Europe established a trade association, the Institutional Money Markets Association, on June 14, 2000 to standardise the way AAA-rated funds are developed and promoted. Money market funds are rated by Moody’s and Standard & Poor’s according to their credit quality, portfolio construction and management discipline. To receive an AAA rating, according to Andrew Ellis, head of business development of the European cash business at Goldman Sachs Asset Management (GSAM), at least 50 per cent of a money market portfolio must be invested in A1 or P1 instruments and above, the average weighted maturity of the debt must not exceed 60 days and no paper must have a maturity of more than 12 months. These criteria are designed to ensure money market funds achieve their primary aim of preserving capital and protecting income by limiting exposure to shifts in interest rates. Within these criteria, money market funds can invest in certificates of deposit, commercial paper, floating rate notes, repurchase agreements and time deposits. Choice of providers Despite this greater standardisation of money market funds in Europe, there are ways for investors to differentiate between the 30 providers in Luxembourg, Dublin and the Channel Islands. Mr Ellis stresses that, above all, “there is a significant virtue in money market funds being managed more conservatively rather than less. When clients invest in money market funds, they would like decent returns but they do not want to lose money.” He says one of the key differentiators between providers of money market funds is the amount of credit research carried out in-house rather than relying on credit agencies. Goldman has split its portfolio management and credit research teams. The credit team comprises 120 analysts around the world while the portfolio managers are based in London and New York. A disciplined credit research team can identify and thus avoid debt that will be downgraded earlier than the credit agencies can, argues Mr Ellis, adding that GSAM’s money market portfolio construction combines “rigorous credit research, interest rate views and liquidity requirements”. Future liquidity Managing the liquidity of the money market fund will have a major influence on which instruments and issuers the portfolio manager will select. “It is important to build up a pretty good idea of the behaviour pattern of investors and talk regularly to major clients so a provider can anticipate future liquidity flows into and out of the fund,” says Mr Ellis. “This information enables a manager to have sufficient liquidity and maximise the yield.” About 20 per cent of GSAM’s funds are on overnight deposit to cover short-term liquidity. Another differentiating factor, says Mr Ellis, is the time at which trades are made during the day. “Managers should be looking to place funds in the market as early in the day as possible to get the best rates as they tend to drop away as the day wears on.” The level of fees charged by asset managers has a major effect on the returns investors receive from money market funds. According to research firm Fitzrovia International, total expense ratios vary enormously, from 0.10 to 2 per cent a year. Ms Barker at BGI agrees that liquidity is an important consideration when investors select money market funds. She argues that while money market funds can be redeemed every day in theory, in practice this may not be the case. “If an institutional investor puts E100m into a fund with E300m in assets, it would be difficult to redeem all that money on the same day,” says Ms Barker. “The size of money market funds makes a difference especially for larger investors.” To gain the AAA rating, funds cannot invest more than 10 per cent of their portfolio with one issuer. Ms Barker says BGI will not invest more than 5 per cent with any issuer to “ensure the optimal diversification and risk management. Most issuers comprise between 2 and 3 per cent of our portfolios.” Ms Barker also stresses the importance of an internal credit research team, which BGI argues provides another layer of protection to complement Moody’s and Standard & Poor’s research. As well as the level of fees charged by the asset manager, Ms Barker adds that investors should analyse past performance, particularly the consistency of returns from one year to the next. The need for stable consistent returns is reiterated by Colin Cookson, vice-president and head of liquid asset management at Mellon Global Investments. “Investors in money market funds do not want great returns one year and then bad performance the following year. The size of the fund can affect performance as well. “If a large investor redeems from a small fund, it can impact on performance as it may be difficult to liquidate some positions.” Another differentiation between funds, says Mr Cookson, is the quality of administration and the speed at which investors can redeem their money. This includes the frequency and quality of statements sent to investors. “Mellon has its own administration company in Dublin so we can ensure a high quality service. Some providers use third-party administrators and may not have so much control.” Linked to this is the asset management group sponsoring the money market fund. “The asset manager does not guarantee the fund,” says Mr Cookson. “But an investor wants to know it will help him if there is a problem. An investor should look for a provider to whom money market funds are an important part of its business and who has deep pockets to stand behind the funds if anything goes wrong.” Size considerations Flexibility surrounding size of investment should also be a consideration when choosing money market fund providers, argues Mellon’s Mr Cookson. “An investor may want a fund that is flexible enough to reduce its minimum investment and the balance required in a fund. If the minimum investment is E1m, an investor may need to redeem some of this without having to take out all his money. “Some funds allow investors to retain a balance of zero and then reinvest without having to open a new account. “Another consideration is how late in the day can an investor redeem his investment. We allow investors to make same-day withdrawals up to midday but other funds have a limit of 10am.” For intermediaries, Mr Cookson argues that an advantage of using Mellon is the fact that it will white label funds for them “without having to establish special share classes.” Marcus Littler, head of the institutional liquidity funds marketing team at JP Morgan, agrees that service is one of the main ways investors can choose between money market funds. “Investors should look for an asset manager with a dedicated client service team and with cash portals, which allow money market funds to be traded online for example,” says Mr Littler. “We have a dedicated sales team at JP Morgan.” Mr Littler adds that an internal credit research team is an important consideration for investors. JP Morgan, for instance, has a team of six credit analysts who create an approved list of instruments for the portfolio managers. UBS reiterates the importance of a strong credit research team. It has 15 investment grade analysts around the world who specifically analyse fixed income securities to see if they are appropriate for UBS’ money market funds. One of the key differentiators of UBS from other asset managers is the way it manages the liquidity of its money market funds. Michael Hitzlberg, responsible for money market investments at UBS Global Asset Management in Europe, says: “Clients can withdraw money on a daily basis. We can do this because more than 90 per cent of our investments in money market funds can be liquidated on the same day. Rolling process “Normally, less than 1 per cent of our money market funds are on overnight deposit [which compares to 20 per cent for other asset managers] because we have issues maturing every day. This rolling process of maturities allows us to meet normal redemption requests on a daily basis. We also have detailed information about future subscriptions and redemptions, which enables us to manage the liquidity of our funds.” The IMMA may have attempted to standardise the development and marketing of money market funds but there are still a number of ways for investors to differentiate between them. These include the consistency of past performance, service, quality of credit research, flexibility and level of fees.