This month we talk to Kathleen Hughes about the impact of the financial crisis on money market funds and discuss the factors that investors should consider when investing in a fund.
Kathleen Hughes
Managing Director, Head of Global Liquidity EMEA
Kathleen Hughes, Managing Director, is head of the Global Liquidity business in EMEA focusing primarily on Institutional Liquidity Funds. An employee since 1990, Kathleen was previously head of the corporate sales strategy and head of the relationship management strategy for the Global Liquidity business in Europe. Before joining J.P. Morgan Asset Management, she was a relationship manager and business development officer for the Wealthy Family Group in J.P. Morgan Private Bank in New York. Kathleen obtained a BA in Economics from the University of Richmond, USA.
What changes are there in the way you manage your fund investments as a result of the banking crisis and the turbulence in the money markets?
Since August 2007, when the first ripples from rising sub-prime mortgage defaults began impacting the short-term money markets, J.P. Morgan has been proactively positioning its funds to continue to do what they have always done – provide liquidity for clients with a stable net asset value (NAV). Our portfolios are managed conservatively, with rigorous attention to risk management and to our credit process.
One notable change is that we’ve increased the overnight cash that the portfolios are holding. Before August 2007, approximately 10% of the portfolio would mature on an overnight basis. Since August 2007 our overnight cash position has been between 20% and 40%. This overnight cash is usually in the form of bank deposits or collateralised government reverse repurchase (reverse repo) agreements.
We also reduced exposure to certain asset classes. Some of this was deliberate as we moved away from certain names that no longer met our strict risk management policies, but other reductions were due to significant changes in the issuance market. This was particularly the case with the Asset Backed Commercial Paper (ABCP) market, where there are fewer issuers today than there were 18 months ago, and therefore less for us to buy. However, we still like the asset class and we continue to use ABCP in our portfolios.
One final change has been to our approved list. We’ve reduced the number of names that we are comfortable buying for these portfolios and have also reduced the maximum tenor for certain names.
As the banking industry shows further signs of deterioration, the market is questioning the creditworthiness of all names. We have managed our portfolios defensively for some time now and are focused on direct sovereign exposures and bank names in countries where we have the greatest conviction about the authorities’ ability and willingness to stand behind their guarantees. These countries include the United States, United Kingdom, Australia, Germany, France and Canada.
Our AAA rated stable NAV liquidity funds have zero tolerance for losses and the risk management and credit research resources that we have in place has certainly helped us to successfully navigate the difficult markets of the past 18 months, and in particular the fourth quarter of 2008. Our focus on risk management has served us and our clients well as J.P. Morgan’s AAA rated liquidity funds have benefited from the flight to quality.
For the full year 2008 our international liquidity funds have grown by $77 billion. Globally, we have grown assets by $215 billion, with $112 billion of that coming into our funds since 15th September 2008 (iMoneyNet, Dec 31, 2008). We continue to be the largest AAA rated liquidity fund manager in the international space with $180 billion in assets under management in USD, EUR and GBP denominated funds (iMoneyNet, Feb 6, 2009).
Does this mean returns are lower?
Returns are trending lower due to Zero Interest Rate Policies (ZIRP), not due to changes in asset mix or portfolio construction. If anything our asset mix and the trades that we made in the fourth quarter of last year are now resulting in higher yields in relation to overnight rates. However, this trend will not continue as this higher yielding paper rolls off.
Wouldn’t I be better off investing with a ‘too big to fail’ bank?
I would still argue that a proven and robust credit process, the kind that is provided by a professional asset manager, is even more valuable in times of volatility and uncertainty. An institution’s guarantee doesn’t mean that it can’t run into trouble, and if a bank goes under, investors would have to get in line with the other creditors to claim their money back from the government, meaning they would not have access to liquidity during that time. Investment managers get paid to avoid situations such as this, and our credit and risk management processes have proven this during the past 15 months.
In addition, of the financial names we invest in, up to 90% (depending on the currency) enjoy some form of government support, for example from guarantees, political support or equity ownership. This means that we benefit from the government support, but with the overlay of a robust credit process.
Following the events of the past 18 months, I would bet that no investor would blindly buy AAA rated securities or invest in an Icelandic bank just because the deposit rate is high. Those days are behind us and the need for credit expertise is back in vogue.
Will the fund accounting rules change because of recent events?
Accrual accounting or amortised cost accounting is a methodology that has been with our industry for over 30 years and has weathered many storms and credit environments. This method is permitted both by international accounting standards and by UCITS regulations. In times like this, it’s normal to question aspects of our industry such as amortised cost accounting, but it would be foolish to abandon a proven and valid approach such as this.
In our portfolios, we hold very high degrees of liquidity in the highest credit quality, shortest term assets. We hold our securities to maturity and as such, amortised cost accounting is the appropriate approach. In the European and UK market there are non-IMMFA money market funds that do not use amortised cost accounting and as a result may have focused on yield as opposed to capital preservation. The very nature of amortised cost accounting forces managers to be very conservative in their approach.
IMMFA stable NAV funds, like their counterparts in the US known as 2a-7 funds, are required to mark their portfolios to market at least weekly and compare the MTM (mark-to-market) price with the amortised cost price. There are strict escalation procedures (governed by both the regulators and by IMMFA code of conduct) that must be followed if the MTM deviates as little as 10 bps (basis points) from the amortised cost of the portfolio.
Will stable (CNAV) funds survive?
Yes, I believe that there is an important place for CNAV (Constant Net Asset Value) funds within the broader money market fund universe here in Europe. We’ve seen assets flow into CNAV funds as they’ve been favoured for their conservative approach over the non-CNAV money market funds that exist in Europe. For example, during 2008, the CNAV money market fund universe (AAA rated funds) increased in assets by 28% or $128 billion (iMoneyNet, Dec 31, 2008), while the local German money market industry lost 22% of assets (Source: Bundesverband Investment und Asset Management).
One thing that would help would be for investors and regulators across Europe to recognise that CNAV or IMMFA style funds are very different from other money market funds in Europe. In the US, the term ‘money market fund’ is reserved only for the stable NAV or 2a-7 money market funds. In Europe, the term ‘money market fund’ is widely and, arguably, loosely used, encompassing everything from the most conservative IMMFA funds to enhanced yield and short-term bond funds that are managed with more risk in the portfolios.
What should an investor consider when investing in a fund?
First and most important is the experience of the manager – investors should look for an experienced portfolio management team, credit research team and risk management team who have managed stable NAV money market funds through many different market and interest rate environments. J.P. Morgan has a long history of managing stable NAV funds and our money market fund business comprises 45% of the assets in our global asset management business.
Investors should also choose large funds that are an important part of the broader asset management business that they are associated with. This is a sign that they are well resourced and that the rest of the organisation is committed to the success of the money market funds business.
In addition, investors may want to consider funds with a highly diversified client base, thereby reducing risk from market events that may particularly affect one type of client. An ideal fund would have a variety of client types including corporates, pension funds, banks, central banks, asset managers, other financial institutions and private clients.
The flows that the manager has experienced during 2008 and importantly in the fourth quarter of the year may also be a guide when choosing a fund. The fourth quarter was the biggest stress test that our industry has ever undergone and in general, the industry has passed this test with very high marks. Clients have distinguished between money market providers, however, and the flows can tell a story.
Finally, an investor should consider fees. Experienced portfolio management, robust credit analysis and risk management do not come for free. When you invest in a money market fund you are buying the expertise of the manager. Funds that are priced too cheaply could cause one to question the resources behind the fund.
How do treasurers use money market funds and has this changed in response to the crisis?
We have seen an increased use of money market funds for a variety of reasons. Treasurers have become increasingly unwilling to rely solely on credit ratings when making investment decisions, but some treasury teams who were investing directly in money market instruments do not have the resources to perform credit analysis themselves. Therefore, they have switched to funds, recognising the benefits of the credit analysis that is behind funds such as those offered by J.P. Morgan.
We’ve also seen some treasurers move away from bank deposits in favour of money market funds as a means of accessing a broad and diversified portfolio. Some treasurers have grown uncomfortable with high concentrations to a single counterparty.
Finally, we’ve seen recognition by treasurers and other investors that not all money market funds are created equal. The largest and most experienced money market managers, such as J.P. Morgan, have benefited the most during this trend.
What questions are customers asking and what advice are you giving them?
Clients are looking for more information across the board – more transparency as to our investment process and also our portfolio holdings. Clients, and treasurers in particular, have stepped up their due diligence on managers and I’m sure this trend will continue. I would advise any client to demand as much transparency and information as possible from their managers.
Our clients are also asking us about government-only liquidity funds – an emerging sub-asset class in European money market funds, in which we’ve led the way with the largest US treasury liquidity fund, the first and largest euro government liquidity fund and one of the first pure sterling gilt liquidity funds.
These stable NAV liquidity funds are invested solely in short-term government debt or repurchase agreements collateralised by short-term government debt, and have been popular with treasurers looking to diversify and in some cases add exposure to sovereign or government issuers.
My advice on these types of funds would be to think of them as a complement to traditional liquidity funds. One thing to be aware of in a ZIRP environment is that these funds will be printing very low yields. Many providers, as well as J.P. Morgan, have closed their US treasury funds to new investors; instead, many clients are now using our traditional USD Liquidity fund or they could consider our newly launched US Government Liquidity fund, which invests in US government agency issued securities and repurchase agreements backed by agency paper.
Disclaimer
The opinions expressed are those held by J.P. Morgan Asset Management at the time of going to print and are subject to change. This material should not be considered by the recipient as a recommendation relating to the buying or selling of investments. This material does not contain sufficient information to support an investment decision and investors should ensure that they obtain all available relevant information before making any investment.
J.P. Morgan Asset Management is the brand for the asset management business of JPMorgan Chase & Co. and its affiliates worldwide. The above communication is issued by the following entities: in the United Kingdom by JPMorgan Asset Management (UK) Limited and JPMorgan Asset Management Marketing Limited which are regulated by the Financial Services Authority; in other EU jurisdictions by JPMorgan Asset Management (Europe) S.à r.l. Issued in Switzerland by J.P. Morgan (Suisse) SA, which is regulated by the Swiss Financial Market Supervisory Authority FINMA; in Hong Kong by JPMorgan Funds (Asia) Limited, which is regulated by the Securities and Futures Commission; in Singapore by JF Asset Management (Singapore) Limited, which is regulated by the Monetary Authority of Singapore; in Japan by JPMorgan Securities Japan Limited which is regulated by the Financial Services Agency and in the United states by J.P. Morgan Investment Management Inc., which is regulated by the Securities and Exchange Commission.
