How has the concept of money market funds evolved over the past couple of years and how has the inclusion of ‘rogue’ assets such as mortgage-backed securities within cash funds damaged their image?
The concept of money market funds continues to evolve in Europe. One thing to note is that the term ‘money market funds’ can mean several very different things in the pan European landscape – from the most conservative, stable value IMMFA (Institutional Money Market Funds Association) funds that are the cousins to the US industry right up to all types of “cash plus” funds that may have lost value and therefore lost cash for their investors in the stressed markets of 2007 to 2009. JPMorgan focuses mainly on the stable value space and I will limit my comments to that industry as it’s the one that I am most familiar with.
Versus the rest of the pan European industry, I would say that IMMFA funds performed extremely well during the financial crisis, as no investors in IMMFA funds lost money. IMMFA funds also experienced dramatic net inflows over that same time period, so clearly the public favoured the most conservative funds in Europe over the longer dated or higher risk variety of cash funds. Between 2007 and 2009, the IMMFA industry took in $131bn (€96bn) in assets and JPMorgan accounted for $72bn of those flows*.
The good news on the European front is that CESR, the pan European regulator, has taken a real interest in the classification of money market funds in Europe, issuing a consultation paper late last year. CESR has proposed a two-tiered approach to money market funds and risk in Europe and could allow “short-term funds” (most similar to IMMFA funds) to coexist with “long-term funds” or money market funds that take on longer duration or interest rate risk and possibly credit risk.
What do money market funds typically invest in?
IMMFA money market funds typically invest in the highest rated, short dated money market instruments. These may include overnight bank deposits, term bank deposits and bank certificates of deposits, floating rate notes, commercial paper, asset backed commercial paper, tail end bonds and repurchase agreements.
Different managers will have varying degrees of resources on the credit analysis side as well as on the risk management side. Investors should ask questions when they see their manager investing in more complex securities such as asset backed commercial paper to ensure that they are comfortable with the resources and controls that the manager has in place to correctly evaluate complex instruments. Managers should no longer just accept an agency rating, but should be doing in-house credit work on all securities in their portfolios.
How has Lehman’s collapse affected the screening and due diligence of underlying investments in money market funds?
The Lehman collapse may have been a wake-up call for some managers, but at JPMorgan, we had a very robust credit team, risk management process and stringent internal guidelines that pre-dated the crisis. These processes proved extremely valuable in helping us to navigate the fallout of Lehman as well as the ensuing volatility in short term credit markets in the fourth quarter of 2008.
As a result, our screening and due diligence has not materially changed. I would say, however, that the level of screening and due diligence by clients or potential clients (ie investors in money market funds) has risen dramatically. Investors are demanding much greater transparency, improved risk metrics and access to senior management. Clients want to understand particular ‘credit stories’ and really dig into our process and internal guidelines.
How do you pick the right issuers? Is credit quality the most important selection criterion?
There are many criteria that an issuer must meet before gaining approval for potential use in our money market funds. Credit quality is certainly critical; however, there are several factors that must be considered. We look at how an issuer trades in the secondary market, how much of a particular issue we currently own and what the current concentration of that issuer is within a portfolio.
2008/2009 we also saw the emergence of government guarantee programmes for certain issuers, bringing an entire new level of complexity to the process of approving credits. No two guarantee programmes were identical so we needed in-depth analysis around the legal structures themselves in order to make the correct credit call. One of the biggest considerations was drawing the line between the strength of the guarantee – the sovereign’s willingness to pay – and the strength of the sovereign itself – its ability to pay. All sovereigns were more than willing to backstop their banking systems; however, not all had the means to do so. This was a new level of analysis for us at the time.
