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Credit crunch takes shine off money market funds

LONDON (Reuters) - Europe’s Triple-A rated money market funds no longer look like the ultra-safe bets they once were, as redemptions soar and differences in returns emerge on the back of the squeeze in global credit.

The funds have for years offered corporate money managers a secure location to store cash in the short-term while still getting higher returns than those offered by banks and all but guaranteeing no losses on initial investment.

Their conservative approach to investing, chiefly in copper-bottomed, highly-rated securities, meant that there was little difference in the returns and conditions offered by the various funds on the market.

But a spike in outflows due to investors scrambling for cash across Europe in recent months, has forced some managers to sell assets at a loss and allowed others to scoop up securities at a bargain, bringing about sharp disparities in performance.

One of the biggest U.S. funds, the Reserve Primary Fund, in September saw its net asset value fall below one dollar -- meaning investors lost money they had initially put in, and triggering a flood of withdrawals across the sector.

Market players say the result is investors have become more demanding over the details of how their money is managed.

“The failure of the Reserve Primary Fund in the U.S. has shown that primary credit research is necessary and relying on credit ratings is not sufficient,” said Dan Phillipson, product manager for cash solutions at PIMCO.

Some funds have suffered as asset-backed securities (ABS) and special investment vehicles (SIVs), which had looked like ultra-safe bets, plummeted in value amid the turmoil in the banking and property sectors.

One player to have benefited from the shake-out is Prime Rate Capital Management, which posted the best yield among dollar funds as of December 5, according to iMoneyNet and broker Tullett Prebon.

“We are very assiduous in finding value, and have been able to buy some interesting bits of paper because we are outnumbered by forced sellers,” PRC boss Chris Oulton told Reuters.

The 3.83 percentage point yield differential between the best and worst performers in dollar-denominated funds revealed by the data has prompted investors to become more discerning, with the worst funds returning less than official interest rates.

The sector weighted average yield of Institutional Money Market Funds Association (IMMFA) distribution funds as of Dec 5 was 1.75 percent in the case of dollar-denominated funds and 3.75 percent for euro-denominated funds.

CLOSER LOOK

One manager at a leading Triple A money market fund provider, who did not want to be named, said that clients now want to know details about the investment process, before deciding to put their money in a fund.

Money market funds are designed to act a little like bank accounts. Their prime goal is to preserve capital -- maintaining a constant net asset value (NAV) by investing in secure, liquid assets, with enough cash on hand to meet daily redemptions -- usually about 10 percent of the fund.

Oulton puts PRC’s strength down to tougher internal rules than those set by the Institutional Money Market Funds Association (IMMFA) and by ratings agencies, with lower concentration and maturity limits.

He now expects the industry as a whole to become more cautious, with providers introducing more portfolio constraints. “These are after all liquidity funds - you need to be able to accommodate large redemptions if needed,” he said.

Although no European money market fund has publicly “broken the buck” -- where NAV drops below $1, 1 pound or 1 euro -- the sector has not escaped redemptions.

There was a sharp rise in outflows last autumn as European governments moved to guarantee cash deposits, putting money market funds at a disadvantage to the banks. And U.S. investors in European funds became alarmed after difficulties at home.

Lipper FMI, a Thomson Reuters company, reported net outflows from money market funds of 68.1 billion euros ($91.83 billion) in September and 41 billion euros in October.

Donald Aiken, chairman of IMMFA, plays down the level of outflows in Triple A rated funds, however. He said assets under management in IMMFA funds, which represent 80 percent of the European Triple A money market fund universe, stood at $546 billion at the start of December, up 10 percent in the year.

Yet according to review by consulting firm Mercer, reduced liquidity has resulted in sellers taking a capital loss on many cash instruments not held to maturity.

“We are aware of a small number of cases in the UK where the cash fund manager has stepped in to meet any shortfall in value; in others, withdrawals have been prevented or even received a lower value than originally invested,” said Nick Sykes, Mercer’s European director of consulting. “These latter funds are said to have broken the buck.”

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