When knowledge is power
Recent market movements have had an unsettling effect on some money market funds, and investors found they were carrying more risk than they had assumed. To avoid nasty surprises, you need to ask the right questions of your funds at the outset. These include: is the fund a stable NAV fund? And what of its independent rating? Since the term money market fund has been applied to a variety of product, where MMFs are concerned, information is key, and the key to a sound investment is knowledge.
The recent subprime crisis has �resulted in higher levels of volatility and some significant losses for several high-profile cash funds. This unexpected occurrence was due to the money market fund’s exposure to longer dated Asset Backed Securities and Collateralised Debt Obligations. Thus, investors who thought they had put their money in the safest asset class of all may have experienced a nasty shock when they found they were invested in areas that could �fluctuate this widely. A true fund? So how has this happened? When is a money market fund not a �straightforward cash investment? This issue has arisen as, over the years, the name money market fund has been applied to a variety of �different products. In particular, the distinction between AAA-rated stable Net Asset Value (stable NAV) and other money market funds (MMFs) has seemingly become blurred. These �vehicles actually use widely different instruments and target very different risk and return �profiles, but they all refer to ‘money markets’ in their �naming �conventions – hence, the potential for confusion and, more �worryingly, the potential mismatch between investors’ expectations and the risk profile of the fund. It is important, therefore, when �evaluating an MMF to ask the right questions of a provider, such as, “Is the fund a stable NAV fund?” A stable NAV fund traditionally invests in high-quality, short-maturity fixed-income instruments within strict credit, �diversification and maturity guidelines. It will seek to maintain a stable NAV and offers same-day liquidity. Investors can generally trade the fund on a same-day basis and the yield is calculated daily after the fund closes. What’s in a day? Another good place to start the �evaluation process is by looking at a fund’s independent rating. Rating agencies such as S&P, Moody’s and Fitch assign a specific rating to stable NAV funds (AAAm, Aaa/MR1+, AAA/V1+ respectively). When a fund is rated by multiple agencies, it must adhere to each agency’s guidelines, which all differ slightly from each other and put restrictions on the fund’s investments. In light of recent events, it would also seem prudent to find out about the investment manager’s internal guidelines and procedures. Some examples would be any underlying asset in the fund cannot be rated less than A-1/P-1, or positions cannot be greater than 5 per cent of the portfolio. It is also important to learn about the credit approval process of the fund complex: How does the manager �evaluate credit quality and determine what is appropriate to buy in the �portfolio, and are trades subject to independent internal credit �department analysis? The investment choices made by the portfolio manager will impact a fund’s performance, which will differ greatly, depending on the quality of these investments. Overnight stay or longer? Knowing what percentage of the fund is invested in overnight liquidity and how much of the portfolio is maturing within three months will �provide an investor with clarity on the liquidity of the fund. With many products bearing the name Money Market Funds, having a structured set of questions to ask a money market provider can help an investor sort through the vast array of cash-management solutions �available in the marketplace today and will also assist an investor make the appropriate investment.
