Liquidity, security, yield, fund size, experience – what matters most when choosing a money market fund? This section provides an overview of the selection process and the questions treasurers should be asking in order to find the right fund.
Amending treasury policy
Your investment policy may be subject to restrictions, rules or regulations. Are money market funds (MMFs) included in your policy’s list of permissible investments?
Most companies wishing to invest in MMFs must seek Board or treasury committee approval for the use of this form of investment. This section of the handbook provides you with the information required to prepare the necessary documentation for the approval process and the process of choosing which MMFs to use.
Choosing a MMF – things to consider
Spotting the differences
In a stable market environment, the differences between the funds would be expected to be marginal. All AAA-rated MMFs are designed to operate within a safe box that restricts how they operate, creating a large degree of homogeneity in the products.
But given that there are small yet significant divergences in investment and credit processes across the different providers it would be wrong to conclude that all funds are the same. So, as well as considering the risk areas highlighted earlier, here are some additional suggestions as to how you can choose between the funds that are available. We’ll start with some practical issues.
Size of fund
Size is important. Larger funds offer material advantages to investors in a number of ways. Quite apart from an ability to accept larger investment volumes, a larger fund normally implies greater shareholder diversity and the actions of a single investor become less of a risk. The greater the number of investors and the more diverse they are in terms of character (and therefore liquidity requirements), the less chance there will be of co-incident redemption pressures. In turn, this implies that a fund manager can be more flexible in its liquidity planning and asset allocation bringing the potential to extend a greater proportion of the overall book into longer-dated and higher-yielding securities.
Scale also means the fund’s presence in the money markets is more significant and buying power is improved thus optimising yield potential. Market presence also gives the fund the ability to develop or persuade dealers to make secondary markets in assets that might need to be sold to meet any unplanned redemptions.
An often overlooked feature of fund size is that the MMFs business is scalable – the larger the fund, the more profitable the operation for the fund sponsor and the more committed they will be to continued product development. A fund manager is incentivised to increase assets under management since, without performance incentives, this is the only way in which its income can grow.
Another advantage enjoyed by larger funds is that they are better able to absorb the costs of regulatory change. “It requires a significant investment to meet the requirements of the new regulation,” says Roger Merritt, Managing Director, Fitch Ratings. “This is a business that has always required a certain amount of scale and the scale threshold has risen as a result of recent regulation.”
If you are a large investor relative to the size of fund (say, more than 2% of the fund), you will find that the fund manager will ask you when you are likely to want your money back. One of the key functions of a fund manager is to understand the motivations and likely liquidity requirements of its larger investors to position the fund accordingly. It is perfectly normal for some fund managers to seek agreement on provision of an informal notice period on redemption of larger amounts.
If, as a large investor, you are unable to give the manager some certainty they will have to keep the fund shorter and more liquid. This may reduce the overall return for all shareholders equally, undermining the appeal of the fund to other shareholders and making the fund offering less attractive generally.
The Weighted Average Maturity (WAM) of the fund can give a clue as to how liquid the fund is but it is more a measure of interest rate risk exposure. Currently, funds are keeping primary liquidity of around 25% of their portfolios in very short or otherwise very liquid instruments (eg repo, bank deposits and treasuries) and a further 30% or so in secondary liquidity (eg CDs).
In stable market conditions, total fund liquidity (ie, primary and secondary) can be as low as 30% but, in any event, would vary to reflect an individual fund’s client base.
Rule 2a-7 by the SEC requires institutional money funds in the US to structure their portfolios such that a minimum of 10% of the fund’s assets mature within one day and a minimum of 30% mature within one week. In contrast, IMMFA members are now required to maintain 10% in overnight liquidity and 20% of fund assets in one-week liquidity. Primary liquidity instruments would generally mature within seven days and, when taken together with contractual asset maturities, meet most or all of the seven day liquidity rules.
There is considerable variation in holdings of bank deposits and CDs. If the fund regularly sees a lot of withdrawals and new deposits (ie it has high turnover), the fund will be more liquid than others and will probably keep a higher proportion in the cash deposit markets. The number, size and type of the investors will influence the liquidity requirements of the fund and, for the fund manager, knowing the investors’ intentions is a crucial part of liquidity management.
It is also crucial that an investor understands the liquidity management policies of a fund manager and form an impression of how fund liquidity is managed; this would include shareholder composition, fund turnover, overnight and seven-day liquidity minima (ie beyond those required by regulators and rating agencies), in what instruments fund liquidity is invested and any external support mechanisms that might be called upon in case of need. You should discuss this with the fund provider but, at the same time, the liquidity issue must be kept in perspective. Most of a fund’s investments are readily saleable and as the mark-to-market value is regularly monitored this should only result in difficulties in the most extreme circumstances.
Dealing cut-off times
Check that the cut-off times are operationally realistic for you and assess the extent to which you might actually need to rely upon the dealing deadline. Some funds apply earlier cut-off times than others. This can enable them to obtain better returns since they might be dealing at a time when the underlying cash markets are more liquid. Conversely, those with a later cut-off may suffer some yield pressures in certain market conditions. It is also worth noting here that a late dealing cut-off leaves less time for the fund administrators and custodians to undertake their daily closing tasks (settlements, accounting, pricing, yield calculation and reporting).
Check you are going to be investing enough to meet the minimum amounts for the initial investment. Subsequent withdrawals may lead to lesser amounts being invested but minimums will apply to the amount of the initial investment and may apply to additional investments and withdrawals. Some fund managers are more flexible than others and will waive minimums if asked.
Different classes of share (in the same sub-fund) may have different requirements in terms of minimum investment amounts, annual management fees, recovery of external fund expenses, category of investor and so on. Generally, share classes are used to create an operational distinction between shareholder classes or to categorise investors according to type or amount of investment. Lower fee share classes tend to require higher minimum investment but, again, fund managers can often be flexible in the variation of minimum subscription amounts.
Few fund managers put performance ahead of security and liquidity but it remains for most investors a key differentiator between similarly structured funds. After fees, the net return on the funds may or may not beat overnight or seven-day rates. The funds aim to offer a reasonably attractive return for a safe and liquid investment. Before management fees, fund yields should reflect market returns close to the fund’s average WAM, since performance is mostly generated by investing further along the interest rate curve. Note also that higher credit spreads on less liquid and longer credit maturity assets will also increase fund returns.
You should examine the recent performance of the funds that you are interested in. Comparison of gross yields gives the best indication as to how a fund manager is performing versus its peer group. Prior to 2007 and given the strict guidelines within which the funds operate, deviation of gross yields from a volume-weighted average for the sector would rarely have exceeded plus or minus five to ten bppa. However, this spread widened considerably during the banking crisis reflecting significantly more volatile market conditions and highlighting differences in fund composition. The spreads in GBP and USD have returned to more normal levels but in EUR the widening has been more pronounced, at between 15 and 20 bppa. Comparison of gross performance measured regularly over an extended period against sector returns will generally give an impression of consistency, in itself a key measure. Again, EUR yields have displayed the greatest volatility in recent times – unsurprising given uncertain monetary conditions in the Eurozone.
Comparison of net yields (which is what really matters to an investor) will reflect fund pricing and any fee rebates that apply. Some funds seem consistently to outperform others by a small margin. But remember, performance is simply a result of the fund’s investments. As Jonathan Curry, Global Chief Investment Officer, Liquidity, with HSBC Global Asset Management explains, if one fund is constantly and significantly outperforming others, the reasons should be established.
“If a fund is a consistent high performer or consistent low performer that would not necessarily exclude them, but one would want to understand why the fund is an outlier,” he says. “It depends what is driving the funds on a relative basis. Is the fund taking too much risk, which is why its performance is so strong? And if the performance is consistently lower one would consider the converse – is the fund running a lower risk profile than the average provider?”
When comparing performance make sure you are comparing like with like. There are various differences in the way that performance can be measured, different day counts for interest calculation, different accrual and mark-to-market procedures and different approaches to the recognition of realised gains and losses.
iMoneyNet and IMMFA have agreed the basis on which performance figures are compiled so if you look at figures in the iMoneyNet tables you should be getting consistent data, certainly among the IMMFA members.
When looking at yields in the performance tables, remember that an investor receives the net return. It is obvious that the level of fees and expenses has a direct impact on the net return.
There had been a lot of competitive pressure on fees but this has waned somewhat as funds have become more differentiated. Funds with higher fees may still discount the fees or offer rebates, if asked, however.
Large (or otherwise desirable) investors may be able to negotiate some form of rebate but the definition of large varies from fund to fund although when there is a wide variation between fund returns or fund offerings are considered competitive for other, perhaps structural, reasons, fund managers are less likely to agree rebates or discounts. As a rule of thumb, an investment of more than 2% of a fund’s total assets would be considered meaningful by a fund provider. Funds vary as to how and when any rebate is paid. Funds originating in the US (where the practice is not permitted by law) may be precluded from discounting through the operation of internal policies.
In some cases, fund managers may recover certain external fund costs (eg custody and administration fees) from investors at the same time as charging an annual management fee.
Mostly, however, these costs, along with portal fees or use of system charges and commissions paid to distributors or introducers, are absorbed by the fund manager as part of its management fee. If the Total Expense Ratio (TER) is the same as the annual management fee, then external fund costs are being absorbed.
What are you chasing?
How important is five basis points, 5bp or 0.05% to you? You may find the extra income is not worth chasing. If your allocation of a treasury surplus to a money fund is driven purely by investment objectives, then 5bp (per annum) may be important. If it is driven by the need to find a safe home for balances requiring daily liquidity (ie a very high degree of liquidity is required), then the overriding imperatives are safety and liquidity in which case the loss of 5bp might be viewed as an acceptable cost for easier liquidity. There is also the question of whether 5bp represents a significant cost in absolute terms. Add to that the cost (including in management time) of switching and settling investments and any marginal benefit can be eroded quite quickly.
Even within AAA-rated MMFs there will be a range of risk. This can be very difficult to detect but using the information in this handbook you will be able to identify the slight differences in portfolios.
Since MMFs tend to invest in similar instruments, investors who use several funds may not diversify risk as much as they think, as the funds may well have some holdings in common.
“If a fund is a consistent high performer or consistent low performer that would not necessarily exclude them, but one would want to understand why the fund is an outlier. It depends what is driving the funds on a relative basis. Is the fund taking too much risk, which is why its performance is so strong? And if the performance is consistently lower one would consider the converse – is the fund running a lower risk profile than the average provider?”
Jonathan Curry, Global Chief Investment Officer, Liquidity, HSBC Global Asset Management
Investors should undertake their own due diligence. A good starting point would be the funds’ annual and semi-annual reports together with their monthly fact sheets and portfolio holdings data that funds will generally make available upon request. Talk to the fund manager about their investment and risk management policies and portfolio strategies and look at what they invest in and which instruments, sectors or countries may be excluded from their limit lists. This latter point is important given that funds’ counterparty limits change regularly according to market sentiment and credit assessments (eg withdrawal of limits, restrictions of maturities, sector or portfolio concentrations and so forth). Read the credit rating reports. Above all, satisfy yourself that the fund will be invested as you would have invested it and that the fund manager can be trusted to act in your place.
Information and transparency
Market pressures and regulatory changes have meant that the funds routinely provide information on portfolio holdings to investors. Some funds will provide information on their largest holdings only whilst others are prepared to issue a list of all holdings. Some publish details daily through website access and others restrict disclosure to those conducting initial due diligence and may, even so, incorporate a delay of up to one month. Information provision is helpful but, for it to be of any real use, investors would need to be capable of assimilating the information and there is a danger they could be overwhelmed simply by the volume of data provided. Industry practices in disclosure of portfolio holdings have been standardised to a degree but there is, as yet, no general requirement in Europe, as is the case under the SEC revision of Rule 2a-7 in the US. IMMFA’s Code of Practice does require disclosure of portfolio holdings information upon request and some fund providers routinely list top portfolio holdings data in their monthly factsheets.
In addition to portfolio asset information, funds disclose additional risk measures on a regular basis. These may include weighted average life (WAL) and liquidity. IMMFA’s new Code does require that members disclose monthly (again, upon request) their liquidity profiles showing asset maturities in prescribed buckets and that the fund WAM and WAL is also provided weekly to support publication of the IMMFA Money Fund Report.
In the US, the SEC implemented changes to Rule 2a-7 in April 2016 to ensure that MMF investors have access to relevant information for evaluating a fund’s risk levels. Under the new rules, funds are required to disclose on a daily basis information relating to daily and weekly assets, daily market-based NAVs, net shareholder flows, and sponsor support (see Sections 4 and 5 for more information).
Investment management style
Although all fund providers undertake their own investment management there are many differences between them. For example, the fund may be managed by:
Dedicated MMF investment manager(s).
The fixed income investment team.
The treasury department of the bank or financial institution.
The short-term fund management team.
The investment managers may also be located in different locations. For example, managers based in the US invest in several of the dollar funds. Ask the fund provider how they manage investment of the fund and what the investment guidelines are. Many will be happy to arrange a meeting with the fund managers or other specialists working directly with the portfolio managers.
Quality, experience and integrity of the manager
The quality of the manager matters:
Are they experienced and efficient?
What is their market reputation?
Are they independent specialists or part of a larger financial services group?
What systems do they have and how quickly can they report?
How do they monitor and value the portfolio?
How is compliance with policy guidelines monitored and managed?
Is liquidity fund management ancillary to wider group activities or is it a discrete business for the fund provider?
Everyone agrees this is important and there are real differences in the way that different funds handle investors. Some funds (though fewer than previously) have dedicated client service desks while others rely upon their administrators to field all client orders. Investors should establish how they will deal with the funds. Telephone and fax had been the usual method of execution and confirmation of orders but increasingly internet-based portals are being used to execute subscriptions and redemptions and as a source of fund data. Not all funds are listed on all the portals.
Client account management and management reporting is an important feature and standards vary between the funds and their administrators.
Then, how are queries handled and problems solved?
What paperwork is prepared and when?
How are statements produced and rates advised?
Who is involved in doing what?
Who is behind the scenes?
Many investors see the investments in MMFs as part of a broader relationship with the fund manager. They will give preference to funds provided by their banking partners where they may be given ‘relationship credit’ for using the funds. The commercial and investment banks are particularly keen to encourage this. The more specialist fund managers are keen to emphasise their specialist skills and their independence and it may well suit an investor to keep separate its treasury investment and banking activities.
“Who the corporate’s relationship banks are, and whether those relationship banks are involved in credit participation is often a factor,” says HSBC AM’s Curry. “If that is the case, some clients reflect that in their allocations to different MMF providers.”
Some commercial and custody banks offer sweeps from operating bank accounts to money market funds. Thus surplus cash is invested ‘automatically’. In fact, these arrangements are not always as automatic or as efficient as they seem. Movements to and from the fund have to be made intraday as the fund needs to invest the monies. There may be extra fees charged for this sort of arrangement and dealing cut-off times may be earlier. The effect is to tie the fund relationship to the bank providing the operating bank accounts.
Investing in a fund
When investing in a fund it is easy to talk about account opening but keep in mind you are investing in a fund and will be a shareholder along with all the other investors. It is not the same as having a deposit account with a bank. Typically due diligence will involve the following:
Read the documentation
Prospectus and Key Investor Information Document (KIID).
These will tell you a lot about the fund. The prospectus is a difficult document to read but under UCITS rules a simplified or summary prospectus can be issued. The KIID (issued in accordance with UCITS IV) is a simplified summary document that pulls together all the key information on the fund but it is no substitute for the full prospectus. The prospectus should be read and understood as it is the legal basis on which you are contracting out investment of your surplus cash. It may also give clues as to any differences between the funds.
Fund annual report and accounts
Whilst only a historic snap-shot, annual and semi-annual reports contain useful information on how the fund is progressing together with the investment advisor’s view on markets and details of the portfolio composition.
Rating agency reports
Much easier to read are the rating agency reports, which provide detail on performance, asset mix, major investments, share classes, maturity profile and credit quality. Fund ratings should only be the starting point for more in-depth due diligence and the rating agencies are usually very happy to field questions of a general nature from corporate and institutional investors (in fact, they encourage enquiries since it gives them insight into investor concerns and criteria).
Fund manager reports and fact sheets
Fund managers produce periodic reports that provide high-level information on fund performance, asset mix and maturity profile. Most will, on request, provide additional portfolio information between annual and semi-annual reporting dates though, as noted above, the standard of information provided informally can vary widely.
The application process for establishing an investment “account” is similar to that associated with executing a bank account mandate and is no less meaningful. It takes a short while, especially if you do not have an existing relationship with the fund provider. As with a bank mandate, strict due diligence and anti-money laundering rules mean that checks have to be made and appropriate documentation completed. Dealing arrangements and other operational details also need to be agreed.
These are generally straightforward but should be reviewed to ensure that there are no issues with signing authorities or other procedural and/or dealing capacities. This is particularly important where execution via a portal is concerned since secure portal access would generally imply a dealing authority.
Establish the dealing process
How do you invest?
How do you handle settlements?
What are the cut-off times?
How do you call monies back?
What if there is a problem?
Who do you speak to about what?
Are the people you speak to third-party administrators or the fund manager’s staff?
How does it all work?
How and to whom are transactions confirmed?
Advice of yields
Remember that a feature of MMFs is that the rate is not contracted at the time that you invest. It is only calculated and posted after the fund valuation point late in the day. Establish:
How you will record the investment.
How and when you will obtain the rates for each day.
How you will record those rates.
You may not need or want to obtain the rates on a daily basis but remember that the ‘interest’ takes the form of a dividend which will be paid monthly on a distributing (CNAV or possibly VNAV) share or accrue daily in the form of an accumulating share value (ANAV). If you want the percentage return you may have to calculate it.
Phone, fax and email
Establish phone, fax and (if permitted) email procedures with the fund. What confirmations are required and in what form?
Most investors find that, once the procedure is established, dealing with MMFs is much simpler than investing on the money markets with less paperwork and no need for lots of quotes and confirmations to different banks.
Where are funds to be paid to and from?
Establish payment procedures and banking details for each fund and each currency you will be using. Establish repayment procedures and make sure the fund has your full banking details. These should all be standard settlement instructions and a fund will only settle redemptions through payment to the account from which a subscription is made.
You may wish to set up these details as pre-formatted payment templates in your electronic banking or treasury system.
Ensure there will be no loss of value when monies are paid to the fund or returned to your bank. Make sure there are no excessive bank charges.
Cross-border and dollar payments can incur high charges but these can be minimised if you talk to your bank and the fund provider.
Establish how and when you receive the income.
Do you want it paid or added to the principal through issuance of additional shares in the fund? If you are a substantial investor and getting any form of fee rebate, when and how is it settled?
Meet the team
Meet the people you are going to be dealing with. Make sure you establish good working relationships and a regular dialogue.
Know who to talk to
If something goes wrong, you need to know who to talk to, probably customer service staff at the fund manager and/or the administrator. Make sure you have effective contacts.
What information is or will be available on the web about the fund and about your investments?
Can you deal and/or communicate with the fund manager over the web?
What information on the fund is available electronically?
Portals and platforms
Fund supermarkets have been around for some time in the US and Europe and most of the institutional MMFs now provide investors with electronic access to their funds either through their own dedicated internet portals or through third-party platforms operated by custodians, treasury systems providers, other fund providers or independent operators.
The use of portals has grown considerably in the past few years and, despite some concern that they tend to concentrate liquidity flows and heighten redemption pressures at times of market turmoil, growth seems set to continue. Use of an electronic medium eliminates the need to manage the paper flow associated with faxing the fund manager or administrator to execute an order and simplifies the operational aspects of a transaction. This is particularly true in the case of multi-fund portals which typically list numerous funds and offer a single point of market entry and settlement. However, it is important for investors to distinguish between the capabilities and functionality of different platforms and to be clear as to precisely which feature(s) are needed.
Portals – things to consider
A single fund portal may be little more than an electronic order platform and is, otherwise, no different to dealing conventionally. By contrast, a multi-fund portal will offer access to several funds but may impose operational constraints (eg earlier dealing cut-off times).
There are important differences in the models available. A direct model means you simply use the portal to communicate with the fund or its administrator and your investments are, therefore, fully disclosed. An indirect or cleared model might mean that your investment is actually through a third party or a clearing agent that acts as a volume aggregator, pooling a number of investors and then managing the collective investment as an omnibus account in the underlying fund(s). In either event, it is imperative that you know your fund and its intentions and that they know you and yours. This may not be easy with an omnibus arrangement.
Multi-fund platforms offer comparative yield data on the funds listed. Historic performance data and other market data may or may not be available through the portal but more tailored analyses and investment advice is generally not. With the current emphasis upon transparency, portals are continuously seeking to improve how portfolio information is provided and how it can be aggregated across multiple funds. This remains a work in progress since, not only do standards on disclosure need to be uniform between funds, but individual assets also need to have a unique identifier so that they can be consolidated.
Proprietary systems are not designed to help investors monitor their own exposure to MMFs. Third-party systems are better placed and are increasingly capable of reporting consolidated exposures. However, they may not have the functionality required to relieve the investor of the need to manage credit limits through daily allocation. Multi-fund portals concentrate settlement exposure with the clearing agent settling aggregated movements of cash with the individual fund custodians. Where netting of payments is a feature, investors must clearly understand at what level netting is applied and whether residual payments liability is expunged.
Most providers offer account interrogation and can generate customised management reports to suit individual clients’ needs.
Methodologies and confirmatory actions required in the dealing process differ. A third-party portal may simplify this to a single process.
Despite the promises, a portal may not incorporate true ‘straight through processing’ of orders. There can be a requirement for re-keying of orders or instructions at some stage before payments are originated or assets are purchased by a fund. It is important to know what goes on behind the scenes so as to know the risks of failure or error.
Fund documentation and periodic reports and fact sheets may or may not be made available through the portal.
Levels of internet security required will vary according to the way in which investors use a portal. Equally, systems integrity and disaster recovery arrangements will be issues to consider.
Many corporate treasuries already use treasury dealing systems to execute and manage their daily market activities and there is an advantage in being able simply to include MMFs as an additional product on existing dealing platforms. Most of these platforms can handle money fund investments but you should check if you are planning to use your treasury system in this way.
Are there any hidden costs? Investors should suffer no direct additional charges where a fund’s share classes on offer via the portal are the same as those available directly.
However, fund managers pay fees to platform providers, the effect of which is to reduce margins and fund manager profitability. Under such circumstances, a fund provider may be less accommodating on such matters as investment volumes, discounts and rebates. In addition, the efficiencies achieved by electronic portals come at the cost of interaction with a human being and portal investors should expect to be treated more ‘remotely’ than if they were dealing directly with a fund provider or its administrator or transfer agent.
Whether the character of the multi-fund portals and the nature of business they attract suits all funds is debatable and a number of larger and high profile funds have either declined, have been slow to agree to participate or have done so only selectively. One concern shared by the funds is the risk that investors on a given portal may be more susceptible to redemption (or subscription, for that matter) pressure simply by virtue of the way a portal has filtered its fund data. Some regulators have also expressed the view that portal investors are potentially less stable than those investing directly.
The heaviest users of multi-fund portals are likely to be large corporate and institutional investors with a need to deploy significant volumes of liquidity simultaneously and efficiently in a number of pre-approved directions and whose key differentiator might be yield.
They are also attracted by the reduced operational risk associated with the netting of settlements through a single clearing agent. However, less ‘active’ investors (typically, the bedrock of any mutual fund) may value more highly a more intimate relationship with their chosen fund providers and advisors. As with so many other things, the answer is to mix and match according to need.
Money brokers are specialists whose main business is that of an inter-dealer broker in the wholesale money markets. While their principal client base is the financial sector (mainly banks), the money brokers have a significant engagement with the corporate, institutional and public and community sectors. In recent times, the brokers are active in the introduction of clients with short-term cash surpluses to the MMFs who also use the money brokers in the investment (and sometimes liquidation) of portfolio assets.
The brokers have established introduction agreements with many of the funds under which they are paid commissions by the fund manager (ie not by the fund itself). They are generally viewed as helpful in the process of educating prospective investors and promoting the MMFs concept from an informed position – in terms of both the traded money market and their clients’ particular circumstances.
Brokers offer the funds additional distribution and provide investors with an objective viewpoint. A broker might talk to many more potential investors than a fund and will be somewhat more independent in its assessment of fund offerings.