The Time is Now for Money Market Funds

Helen Sanders, Editor

Regular readers of TMI’s annual Money Market Funds Guides will have witnessed the almost meteoric rise in the popularity and acceptance of money market funds (MMFs), growing from US domestic instruments to widely accepted liquidity instruments in other parts of the world, particularly Europe; or, as we described it this time last year, American Idol to Global Superstar. As we are all very well aware, the financial markets have changed unrecognisably since last year’s Guide was published. While the gloss has rubbed off many financial instruments (commercial paper, FRNs and even the comfortable deposit) MMFs are moving from strength to strength, rather like American Idol in fact. After all, like Idol, which now attracts thirty million votes each week (surely as many as the presidential election – perhaps a change to the election procedure is in order) MMFs have shown remarkable resilience. In this article, I would like to look at why MMFs are such a compelling proposition today, and how they might develop in the future, in terms of what they could represent as a global proposition and how I envisage they will be traded in practice.

MMFs have proved their resilience to fluctuating market conditions.

In previous Guides, we have emphasised some of the benefits of MMFs which enable treasurers to satisfy the investment demands of Security, Liquidity and Yield. Twelve months ago, these requirements were valid but for treasurers who have been in the profession for less than 15 years or so, largely untested. A year on, the majority of Boards will have demanded to know from their treasurers the extent to which they have applied these laws of liquidity. For example, various companies with which I work had cash invested in UK bank Northern Rock when its problems first became known. While the loss of this amount would not have resulted in financial collapse, it would have been devastating for the reputation of one in particular, a major charity, and significantly impacted its ability to attract future funds. For any organisation, financial loss through counterparty collapse which could have been avoided by basic risk management is damaging financially, reputationally, and causes serious concern amongst the company’s stakeholders. In the case of Northern Rock and similar cases in other parts of the world, both retail and institutional investors were ultimately protected through government intervention, but amongst institutional investors in particular, this is by no means inevitable. Most companies will have cash deposited in banks which have been subject to their own headlines and speculations. Do we think that there is a realistic threat that money invested in these banks will be lost? Probably not. But this is the point of risk management. We should not be ignoring possible occurrences, even if these seem highly improbable. Our responsibility as treasurers is to identify and manage risk and any investment decision, particularly when investments are not diversified, brings an element of risk.

Diversification

The need for diversification is more acute than ever, not just during the current period of uncertainty but as a wake up call that we have often been complacent during the years which preceded it. With the same pressures affecting the whole banking community, security of capital cannot be assured simply by depositing cash in different banks. As Jean-Claude Trichet, President of the European Central Bank warned recently, the banking market is continuing to go through a major correction. To truly diversify, a treasurer needs to spread his/her risk across instruments of different risk profiles as well as different counterparties, so that risk to each asset is very limited and risk of loss to one asset class is offset by stronger performance in another. MMFs are inherently diversified, with a range of instruments underlying them.

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