The sub-prime mortgage crisis in the US and the ensuing liquidity crisis have had a profound effect on short-term investment options for treasurers around the world. CFOs, CEOs and boards are scrutinising treasury departments closely to see which investment instruments have been selected. Treasurers in turn have been in closer contact with their asset managers and banking partners to understand what is happening in the financial markets and how this is affecting their own liquidity. In this period of uncertainty, what strategies should treasurers be employing in order to achieve security of investment, maintain liquidity and create yield?
A good start would actually be to keep in regular contact with your fund manager. The liquidity crisis may have meant that you put names and voices to the people helping to manage your cash investments for the first time, by building on these relationships, treasurers can learn much more about the instruments that their cash is invested in.
The Investment Strategy Risk Conundrum for Treasurers
Due to the market problems of the past year, it is understandable that security and liquidity are the main qualities that treasurers look for in a short-term investment instrument. But what about yield? Different fund types and investment instruments were falling over themselves to offer investors the best yield ratios up until a year ago, but is this still important? Well, it should be, but it is important that treasurers understand how the yield projections they are being shown have been put together and, as always, if something looks too good to be true then it probably is. This is a theme picked up by Mark Rimmer, from BlackRock, in the
The balance between security, liquidity and yield that treasurers face when making short-term investments is something that François Masquelier, honourary chairman of the European Association of Corporate Treasurers (EACT) tackles in his article,
Even basic bank deposits are exposed to significant risk, as Alain Kerneis, from Goldman Sachs Asset Management, discusses in his article,
A corporate’s risk management policies are tightly linked into its short-term investment strategy, more so today than ever before. David Rothon, from Northern Trust, looks at the risk aspect of MMFs in his article,
Regulations Helping Growth of MMFs in Europe
In Europe, the MMF market has lagged behind the US in terms of assets under management, but recently it has been catching up quickly. A major reason for this has been a shift in the regulatory landscape. Changes to the Basel II capital adequacy framework and the introduction of the European Union’s Markets in Financial Instruments Directive (MiFID) has made investing in MMFs an attractive prospect for banks. Under the original Basel Accord, financial institutions were required to make large provisions against these investments. MMFs were also treated the same as higher risk equity funds, making them relatively expensive for banks to hold. However, this has now changed, as Kevin Thompson, from Fidelity International, discusses in his article
“Additionally, under MiFID, banks will be allowed to invest client money into AAA-rated funds, earning a higher return than just relying on bank deposits,” explains Thompson. “With these structural and regulatory changes coming into place, we expect the market in Europe to grow significantly over the coming years.” As cash from banks floods into the MMFs, this adds to the security of the market from the perspective of the corporate treasurer.
Need For a Better Definition of MMFs
The downturn or even collapse of some short-term investment markets has lead to many calls within the industry for a better definition of what an MMF actually is. As EACT’s Masquelier says, it is important not to confuse treasury-style MMFs with similar looking products that actually have a greater risk profile. “It is unfair and even dangerous to claim that the risk would be the same when the duration of underlying investments is longer (greater than three months) and that the return on investments is clearly greater than the reference indexes (e.g. EONIA, EURIBOR, LIBOR),” explains Masquelier.
“With an AAA-rated stable net asset value (NAV) MMF, corporate treasurers can be confident in the knowledge that they have access to their money on a T+0 basis and they are able to maintain this flexibility,”says BlackRock’s Rimmer. This type of MMF, often referred to as a ‘treasury-style’ MMF, has been a success story of the past 12 months, as treasurers have been attracted by the relative security and liquidity they offer as opposed to enhanced cash funds or bank deposits, for example.
The credit crisis has created an inflection point in the MMF industry regarding how investors view MMFs, perhaps permanently. Karen Dunn Kelley, from Invesco, describes in her article,
Trade organisations agree with the IMMFA in calling for clarity of definition for MMFs in order to avoid previous errors of judgement regarding the underlying asset risk of different short-term investment instruments. François Masquelier says that the EACT, like many national treasurer associations, thinks that distinguishing a treasury-style MMF from other cash funds such as enhanced, cash-plus or dynamic MMFs is crucial. “Turning to ‘pure’ monetary funds with an AAA rating (IMMFA funds) has shown during the crisis that it was possible to guarantee liquidity while offering a solid return greater than the EONIA index (for euro funds),” he explains.
This clearer definition is beginning to take shape, as Kathleen Hughes, from JPMorgan Asset Management, highlights in her article,
This undivided attention on very short-maturity instruments is a big distinction between QMMFs and other MMFs with higher risk profiles. Some longer-term enhanced, dynamic or total return funds implement active strategies that can buy securities maturing as far out as 30 years, which means they have been at the behest of market liquidity when it comes to meeting shareholder redemptions. JPMorgan’s Hughes notes: “Such strategies worked perfectly well until market liquidity vanished in the summer of 2007, forcing the fund’s to sell securities at discounted prices.” These losses were then passed onto investors, which is the last thing treasurers want.
Which Funds to Choose?
Treasurers have started to differentiate between the MMFs that are available to invest in, and the asset managers that are offering the product, with risk factors now being a key factor in fund selection. The size of the fund, its portfolio holdings and the strength of the provider are increasingly under scrutiny. This is something that JPMorgan’s Hughes points out in her article. “The size of the fund, in particular, directly addresses large investors’ fears of being a big fish in a small pond. If you make up too much of the fund, how confident are you that adequate liquidity will be provided?” she says.
The financial strength of the provider is now also a consideration when looking at which short-term instruments to invest in. While mutual fund investments are ‘ring-fenced’ in terms of the fund provider’s balance sheet, the funds themselves are not guaranteed by the asset management company, or the parent bank entity, if one exists. Despite this, many investors believe that if the stable NAV of an AAA-rated fund is in jeopardy, the provider will act to prevent any losses being passed onto shareholders. If this assumption is correct, the provider can only do this if their balance sheet allows it – which is why there is a focus on the financial strength of the provider. This is even the case when investors look at treasury-style MMFs. As JPMorgan’s Hughes states: “These changes have been profound and are likely to be permanent.”
Taking Advantage of Technology
While treasurers can benefit greatly from an active working relationship with their fund managers, technology can also help when it comes to investment decisions. This is a topic that Basak Toprak, from Citi, highlights in
In his article,
Significantly, Citi’s Toprak points out that “while adoption of portal technology grows in the transaction space, they do not replace existing relationships with fund managers or the need to have someone at the end of the phone to answer questions on the investment offering or provide feedback on market developments.”
As the market turbulence of the past 12 months has dealt blows to competing short-term investment instruments, the security and liquidity that treasury-style MMFs afford has seen their popularity rapidly increase, particularly in Europe. Going forward, it is important that investors do not revert to a laissez-faire approach to short-term investments – security and liquidity are the vital components at the moment, but to neglect yield could cost corporates in the longer-term. It is important for treasurers to arm themselves with as much knowledge of the market as possible, which can be achieved by having a good relationship with fund managers, as well as utilising any technology that can simplify and enhance investment decisions, such as MMF portals. The funds industry itself needs to ensure that it is catering for investors by providing accurate and up-to-date information on the investment instruments it offers, and that these are clearly defined with transparent risk profiles. The growth of treasury-style MMFs has shown that, even in tough economic times, there are good short-term investment opportunities out there and, if the industry learns from previous mistakes, these can grow. For example, at a recent conference looking at MMFs, Donald Aiken, the chairman of the IMMFA, said that he would not rule out the return of enhanced cash funds given time, albeit in a slightly different format. By keeping up with industry developments such as these, treasurers can be in a position to take advantage of future market alterations and add value to their company by doing so.
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