Cash & Liquidity Management

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Risky Business: A Crisis for Money Market Funds The current crisis has highlighted some unwelcome volatility in money market funds. In this article the author makes two important points: that while they are necessary, traditional risk tools and measurements such as VaR are insufficient to identify risks, and the classifications provided by the ratings agencies do not always reflect the true risk situation. Better understanding of risk ‘colours’ and more effective methods of measurement are needed and would benefit all sectors of the market.

Risky Business: A Crisis for Money Market Funds

by Ingmar Adlerberg, President, Riskdata.

For corporate treasurers, as for many investors, money market funds are the Fort Knox of investment vehicles. By purchasing debt securities issued by banks, large corporations and the government, money market funds carry a relatively low default risk while still offering high returns in comparison to similar low-risk/liquid products. However, given the current credit crunch, these funds are experiencing unprecedented volatility. Some of those funds may have been investing in riskier holdings that were not in line with investors’ expectations.

Poor understanding of risks led to losses

For example, unexpected losses by French money market funds, in the summer market crisis, caused by poor understanding of exposure to mortgage backed securities and credit, are now a major concern for corporate treasurers and CFOs. Of the total fund universe, some €500bn were invested in money market funds - the typical types of fund in which corporate cash is invested on a short-term ‘riskless’ basis. Yet August saw a major crisis for money market funds. In France, OPCVM sudden losses accounted for more than 50% of year-to-date performance. According to the most commonly used risk models, this type of event should occur once in thousands of years.

A study carried out by Riskdata, the leading provider of risk management tools for the alternative investment market, provides detailed analysis that shows that neither basic risk measures, nor fund ratings succeeded to identify the nature and magnitude of risk.

Riskdata analysed the performance of 2,000 funds on the French market with total assets under management of €1.368 trillion (thus covering most of the volume of the French funds market, which is €1.6 trillion according to official data). The funds studied were grouped into categories based on their stated strategy from completely safe to more aggressive (using the categories of the major fund rating agencies), and Riskdata calculated performance and risk for each category for the year-to-date and for the crisis period from July 15 to August 20.

The analysis revealed two developments which illustrate a disparity between what investors thought they were getting, and what the money market funds delivered, or in many cases didn’t:

1. Traditional risk tools used by investors were insufficient.

2. Rating agencies’ classifications of funds do not always accurately reflect risk

  • Of 333 money market funds, a few suffered losses totalling €17 million during the summer crisis, although the vast majority of funds in this category remain robust and did not suffer any losses.
  • In the treasury dynamic category incorporating 122 funds, 39% lost money in the crisis, with losses of €393m. The average loss in the crisis of the funds that lost money in this category was -1.15%. The year-to-date performance of those that lost money was 1.05%, so over half of their yearly performance was lost in the crisis. The average year-to-date performance of this category as a whole was 1.7%.
  • Of the 88 funds in the treasury dynamic plus category, 50% lost money in the crisis, with losses of €119m. But the average year-to-date return of these funds of 2.1% was superior to the treasury dynamic category, proving that labelling funds in such categories gives no indication of the actual risks being taken.

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