European money market funds (MMFs) are facing continuing low interest rate and market challenges, according to Fitch Ratings, which have forced some fund managers to make fresh adjustments to the exposure and tenure of certain investments, particularly those in Spain and Portugal.
Despite the view of many market participants that euro, sterling and US dollar interest rates will remain on hold until at least the end of 2010, MMFs have not taken this opportunity to position themselves longer on the yield curve, Fitch has said in its ‘European Money Market Funds Quarterly’ newsletter for 2Q10. As a result, the weighted average maturity of AAA-rated European MMFs has been much lower than would be expected in such a stable rate environment.
“Money market fund managers have had the opportunity to build additional yield into their funds, however, the risk-return trade-off has been deemed unattractive in the current market environment,” said Roxana Mahboubian, director in Fitch’s fund and asset manager rating group. “The greater focus has been on managing a high level of liquidity, including overnight exposure, and managing credit risk through lower tenors. As uncertainty over the redemption activity of MMFs continues and liquidity risk is a concern, MMFs are building cash positions close to levels last seen at the height of the 2008 financial crisis.”
The yield differentials between the highest- and lowest-yielding MMFs have started increasing again, albeit modestly. This reflects the re-emergence of MMF managers’ varied risk appetite, as some managers have again become ultra conservative as recent economic data has failed to improve, and market sentiment has become more negative as a result of uncertainty over the future direction of the sovereign debt crisis.
“While MMFs have not stopped investing in southern European countries, managers have regularly updated their list of eligible names, and adjusted exposure and maturity limits for some investments,” added Mahboubian. “Some managers have additionally gone as far as placing specific country limits.”
Between September 2009 and May 2010, the total exposure of Fitch-rated MMFs to Spain and Portugal declined by 25% and 75% respectively, and investments have been limited to the strongest financial names.
The newsletter’s ‘Industry Issues’ section reviews the continuing adjustments that MMF managers have made to the exposure and tenure of investments in certain European countries. It also analyses the Committee for European Securities Regulators’ (CESR) guidelines for a harmonised European MMF definition that will reshape the European MMF landscape by July 2011.
With respect to CESR’s guidelines, Fitch foresees a global convergence of standards addressing interest rate and spread risk exposure for short-term MMFs. However, the agency anticipates that differences will remain for portfolio liquidity and credit risk.
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