Money Funds - Are the harbour walls safe? Tuesday, March 11, 2008
With the turbulence in the markets and credit markets in particular, money funds have found themselves awash with cash from investors seeking a home for their cash during the storm.
Money funds are mutual funds that normally carry a triple AAA rating, whose portfolios are made up of short-term financial assets with high liquidity (Treasury Bills, Commercial Paper etc). InvestorWords quotes
The main goal is the preservation of principal, accompanied by modest dividends. The fund's Net Asset Value remains a constant value ($1/£1 etc) per share to simplify accounting, but the interest rate does fluctuate. Money market funds are very liquid investments, and therefore are often used by financial institutions to store money that is not currently invested. Although money market mutual funds are among the safest types of mutual funds, it still is possible for money market funds to fail, but it is unlikely. In fact, the biggest risk involved in investing in money market funds is the risk that inflation will outpace the funds' returns, thereby eroding the purchasing power of the investor's money.
The emphasis is mine, since this point has been under stress for some time.
Sold to both retail and corporate investors across a range of currencies, the marketing of such funds has traditionally focussed upon five things namely:
- their rating, usually AAA
- their liquidity, normally with daily access
- ease of use
- low risk, diversified holdings versus concentration of risk by holding a bank deposit
- wholesale market rates offered, which are normally higher than rates offered to bank customers
Obviously investor confidence is of paramount importance especially when competing against bank deposits and loss of capital value would come as a major shock to many investors. Mindful of this, a number of funds have been bailed out by their managers to maintain the capital protection illusion. Back in December, the FT reported that more than 10 North American banks and fund managers have collectively injected $3bn into their money market and cash funds since October to stem losses. It added that not all bail-outs have been made public but more were believed to be being drawn up and that the extent of losses is not yet known.
It takes only a tiny loss to push a fund's value below 99.5% and given that such funds have to mark their asset to market, the continued downward pressure on assets prices of even US Federal backed paper will challenge the pretence. When this happens, some investors may panic causing a "run" on such funds.
In common with banks, such funds also tend to borrow short-term and buy long-term paper whilst maintaining sufficient liquidity to meet investor redemptions. However, in the event of higher than foreseen redemptions, the lack of liquidity in the markets could result in funds either having realise cash by selling assets cheap, thereby incurring losses or suspend redemptions. This latter outcome is like a bank shutting its' doors but it has happened with several money fund managers.
You may think banks would be delighted to see their "competitors" struggle. Not so, since many of them are the managers of such funds having seen the benefits of a large chunk of existing business moving off-balance [removing any capital requirement] whilst generating broadly the same returns.
So the challenge is this - as fund balances swell from inflows, managers have to find more investment outlets. In doing so, they have to be more cautious than most given the imperative of preserving capital and having access to liquidity. Yet finding large assets pools matching this profile in the current climate will be immensely challenging. As a consequence, rates offered may have to be tempered, and whilst high inflow levels might allow for that, managers will still feel the need to competitively price their offering.
Mistakes will be inevitably made in these stormy waters. So will the sea defences hold or might urgent and rapid bailing out of these "safe harbours" be necessary or will the scenes around the South of England yesterday be repeated and the harbour walls be breached? Right now, there are many senior executives probably praying for survival.
UPDATE: Financial News has the following report
Legg Mason has provided support to one of its cash funds with a holding in Cheyne Finance to prevent its investment in the structured investment vehicle from dragging the fund down.
Officials at Legg Mason declined to reveal the size of the fund's holding in Cheyne Finance. In December, Deloitte & Touche—acting as receivers for the vehicle—revealed it had agreed to sell the $7bn portfolio to a new vehicle managed by investment bank Goldman Sachs.
Legg Mason has provided $1.57bn of support to a variety of its money funds, according to analysts at investment bank Keefe, Bruyette & Woods, including posting $440m of cash collateral and the direct purchase of $181m of securities.
In November last year, the firm signed letters of credit worth $238m to keep the high credit ratings on two of its money market funds that had a total exposure of $670m to asset-backed commercial paper issued by structured investment vehicles. In October, it invested $100m in another liquidity fund managed by a subsidiary "in order to provide additional liquidity support to the fund."
Exposure to structured investment vehicles has affected a range of money market funds, forcing some asset managers to spend millions of dollars support them in order to avoid the stigma of "breaking the buck"—where an investor receives less than a dollar for each dollar they originally invested in the fund.
Asset managers Northern Trust, Bank of America, Wachovia, Credit Suisse Asset Management, Janus Capital and Morgan Stanley Investment Management have all faced charges or arranged lines of credit related to keeping their money market funds' value at par.