| Money market funds intensify focus on risk even as spreads come in |
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| 30/09/2007 | |
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Money market funds, which constitute an important component of the cash allocation of pension funds, are seeing signs of stability. Spreads for traditional asset-backed commercial paper averaged about 35bps over LIBOR in mid-September compared to 75 to 100bps over the benchmark rate at the height of the crisis. While most of the assets in these funds are invested in US Treasury bills, certificates of deposits and short-term commercial debt, worries persist. That should come as no surprise: some of the largest money market funds invested in CDOs. Funds run by Bank of America, Credit Suisse Group, Fidelity Investments and Morgan Stanley held more than $6bn of CDOs with sub-prime debt in June, according to Bloomberg. Even as spreads have come in, money market fund managers are re-assessing the type of short-term paper to invest in. A number of funds have put into place internal restrictions on the purchase of asset-backed securities. Money market funds have stopped buying extendible asset-backed commercial paper, where the issuer has the option to extend the maturity to a final predetermined date if it cannot repay the maturing debt, according to Joel Friedman, director at Standard & Poor's. Sub-prime woes have prompted asset managers to invest in more liquid and conventional products and shorter maturity securities, says Françoise Nichols, associate director at Standard & Poor's Fund Services. "There is more consideration now for risk than performance." The weighted average maturity (WAM) of rated money market portfolios, for example, has shrunk to about 31 days, down from 36 days in mid-June. Not too mature While the decline in WAM may appear small, it is significant because the financial markets were expecting the Federal Reserve to reduce the federal funds rate, which it did by 50bps. "Such expectations would usually encourage fund managers to go long 50-60 days for rated funds to take advantage of higher yields on securities already in the market," says Friedman. Instead, the managers reduced their WAM because of concerns about liquidity. This does not mean money market funds have not experienced strong net inflows during the sub-prime crisis. Any time a pension fund exits an asset class, it inevitably parks the cash component of its portfolio in a money market fund. The choice of money market fund, however, is benefiting some at the expense of others. "For example, AAAm-rated funds are seeing an increase in inflows, while cash+ funds, which are more likely to have invested in asset-backed securities, tend to have experienced outflows," says Nichols. Some money market funds have been holding 20% to 30% of their investments in highly liquid overnight paper, according to S&P. Additionally, credit teams at money market funds have re-examined and reduced the list of approved issuers, further narrowing what money managers can buy. S&P monitors more than 500 money market funds that it rates in the US and Europe. Based on conversations with these fund managers, the rating agency says that investors are demanding more information from issuers of structured securities about the assets backing the paper. S&P monitors the credit quality, maturity distribution and net asset value (NAV) of its rated money market funds on a weekly basis. A NAV of $1 is important because it signals stability of the principal amounts invested in the fund. If, for example, 3% of a fund's holding is sub-prime debt, and in a worst-case scenario, that asset collapses and we assume a 0% recovery value on the defaulted sub-prime bond, the value of the fund could drop to 97 cents. VB |
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Articles of the same Topic : Cash management |
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