Investment Snapshot: money market funds
With continued volatility in the markets, institutional investors now view liquidity as a key feature of cash as an asset class and they should demand rigorous risk management to ensure this.
For a fund manager, the key risks to be monitored are credit risk, liquidity risk and interest rate risk.
Credit risk
A prudent manager should address credit risk with a robust, proprietary credit analysis process that is independent of the portfolio management process.
Credit guidelines should be hard-coded into automated guideline monitoring systems and these guidelines should be updated in real time to reflect any changes in credit outlook that may occur in fast-moving markets.
A well-resourced credit team is critical in adapting to the changing sources of risk we’ve seen evolve in the money markets since the financial crisis.
Liquidity risk
Liquidity risk should be looked at from both the asset and liability side of the portfolio. Managers now have to adhere to stricter liquidity measures in both the overnight space of 10% as well as the one week space of 30% and 20% in the US and Europe respectively.
Another aspect to prudent liquidity management is having a thorough understanding of the client base and monitoring investor concentration limits.
Interest rate risk
Stable value money market funds in the US and Europe have a maximum weighted average maturity (WAM) of 60 days and a maximum weighted average life of 120 days.
Due to these short-term restrictions, managers only have room to position portfolios between one and 60 days as measured by WAM, and there will often be overriding factors that will influence the positioning of the portfolio.
Stress tests
Prudent money market fund managers will have robust internal models to test portfolios for market stresses including credit, liquidity and interest rate factors, and perform daily or weekly mark-tomarket analysis of the securities in the portfolio.
Furthermore, the events of the past four years have been a real-life stress test – experience and track record are the best tests of all. For pension funds, which have to hold a portion of their portfolio in cash to meet liquidity needs, mitigating risk for this asset class should be at the forefront of objectives.