Cash & Liquidity ManagementInvestment & FundingShort-term InvestmentMoney Market Industry Refocuses on Safety and Liquidity

Money Market Industry Refocuses on Safety and Liquidity

Investors have historically treated all money market funds (MMFs) as commodities, viewing everyone as using the same processes and investment philosophies since the industry started in the 1970s. But last year’s market panic has shown that all money funds aren’t created equal. Investors are refocusing on the reason these funds were created in the first place – to provide a safe, liquid place to invest short-term cash. The industry is doing the same, and has introduced recommendations intended to boost safety, liquidity and yield, in that order.

The Money Market Model

MMFs play a crucial role in providing financing for individuals, businesses and governments in our economy. For example, money funds are the source of funding behind bridge projects, small business loans, credit cards and car loans. Financing would be more expensive and less efficient without money funds.

MMFs are mutual funds that hold short-term securities such as US Treasuries, certificates of deposit, municipal securities, highly rated commercial paper and other liquid securities. Before last September, they were not federally insured like their bank cousins, money market deposit accounts. MMFs had been considered relatively low risk compared with other asset classes because MMFs have a shorter maturity schedule, invest in higher-quality assets and have greater liquidity.

MMFs are considered one of the best new financial products of the last half century. They’re also considered a regulatory success story since the Securities and Exchange Commission (SEC) started regulating them under the Investment Company Act of 1940. After the change was adopted in 1983, the industry grew from US$180bn in assets to nearly US$3.8 trillion in December 2008, with almost 2,000 money funds in operation. Since the start of the MMF industry, only two funds ‘broke the buck’ – or saw the value of their assets fall below the dollar-for-dollar level needed to fully repay investors – compared with 36 bank failures through 27 May, 2009.

The first US money fund – the Reserve Primary Fund – was established in 1970 and grew to more than US$60bn before breaking the buck in September 2008 because of its holdings in now-bankrupt Lehman Brothers. MMF liquidity dried up as investors worried that other funds held similar securities. Fearful of the cascading effects, the government stepped in with programmes to help, including a temporary money-market guarantee programme. The program is set to expire on 18 September 2009, after several extensions to give MMF managers time to establish tougher standards.

Strengthening the Money Market Model

The Investment Company Institute (ICI), the national association of US investment companies, formed a Money Market working group to develop recommendations backing new regulatory and oversight standards.

“The working group’s recommendations comprehensively strengthen money market funds by addressing liquidity, maturity, credit quality, client concentration and disclosure,” Invesco said in an 18 March 2009 letter to clients. “These inclusive recommendations are designed to protect investors first and foremost while preserving the crucial role money market mutual funds play in providing financing for individuals, businesses and governments in our economy. We are pleased to see that the ICI’s proposals are consistent with our conservative investment philosophy, which focuses on our commitment to provide safety, liquidity, and yield – in that order – to our money market clients.”

Specifically, we call attention to the following proposals:

  • Liquidity: Enhance portfolio liquidity by requiring daily (5%) and weekly (20%) liquidity standards and regular stress testing.
  • Portfolio maturity: a) Restrict limits on the weighted average maturity of portfolios from 90 days to 75 days, and b) introduce a new portfolio maturity limit to capture spread risk within portfolios.
  • Credit: a) Prohibit investments in second tier securities, b) require the creation of a new products committee to assess appropriateness of new securities in the marketplace within the context of money market funds, and c) encourage advisors to follow industry ‘best practices’ for determining minimal credit risk.
  • Client concentration: a) Improve shareholder due diligence procedures, and b) require funds to provide monthly disclosure about client concentration levels.
  • Portfolio disclosure: Require money market funds to provide monthly website disclosure of portfolio holdings.

We believe these proposed steps will provide important additional protections for individuals and institutions.

Invesco’s Money Market Complex

Invesco Aim, the 12th-largest US money fund complex by assets, has maintained a net asset value (NAV) of U$1.00 per share. It has avoided any credit issues, and witnessed a rise in assets, from about US$82bn as of 31 December, 2008, to US$92bn as of 30 April, 2009 – outpacing the industry in year-to-date percentage growth. Many of ICI’s proposed changes have been implemented at Invesco since the firm opened in 1980, at a time when risk wasn’t recognised as much in the market and many money funds tried to stand out by stretching for yield.

Money funds that experienced problems were often structured so that the credit team reported to portfolio managers whose compensation was determined by performance. We have always kept portfolio management and credit on a separate-but-equal basis. The focus is on minimal credit risk, with a bottom-up approach concentrating on safety and liquidity. As a result, Invesco didn’t own any securities downgraded below Tier 1 while held in the portfolio during this credit crisis. Its credit process helped the company avoid many of the troubled securities, such as extendible asset-backed commercial paper, defaulted structured investment vehicles (SIVs) and Lehman Brothers.

More than 98% of its money market assets are in institutional funds – most with AAA ratings from the three large rating agencies. It is critical for firms to ‘know your client’ and to talk often with customers, especially their biggest ones, to understand their cash flows and tendency to move money in and out of funds. Invesco strongly believes the ICI’s recommendations are important for the continued vibrancy of the money market fund industry and the health of the national economy.

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