Traditionally a cash deposit was seen as a no risk investment. Perhaps the only risk being attributed to the effects of inflation reducing the capital buying power.
The considerable differences between money market funds were brought to light recently, when a number of investors using the vehicles as a shelter from the tumultuous markets saw their cash assets tumble in value.
The most high profile fund to hit the headlines was the Standard Life Pension Sterling fund. Investors say they were led to believe this was a pure cash fund, therefore providing a lower-risk investment. It was, in fact, using more complex instruments exposed to the weakening American mortgage market, and the fund dropped in value quite dramatically in January.
Floating rate notes (FRNs) and asset-backed securities were introduced to the portfolio without the risks being explained to investors.
Prior to the announcement of the reduction in value on January 14, the fund held over £2 billion in assets and had nearly 100,000 investors. These investors were told that, owing to exposure to mortgage-backed securities, the fund’s unit price was to be diminished by 4.8%, wiping off £100m of its total value.
A statement released on February 11 said: “We have listened to feedback and the concerns of our customers … and have decided to put customers back in the position they would have been before the valuation adjustment on 14 January 2009 ... some customers would not have expected the value of their units to fall by this extent in one day, based on the information we provided on the nature of the fund.”
After admitting there was insufficient information available on the risk level of the fund, Standard Life pumped in £100m of its own money and recompensed customers who had left the fund after the adjustment was announced.
Money market funds saw huge inflows in 2008. Equities were plummeting, bonds were not doing much better and interest rates were high – around the 5% mark for most of the year.
Cash was king. Figures from the Investment Management Association (IMA) show that over £242m (net) was pumped into the Money Market sector for the calendar year of 2008, with a monthly peak reached in July when inflows were £55m.
Most investors use the vehicles as income producers, particularly during periods of high interest rates or as safe havens from falling markets, because placing cash in a variety of bank or building society accounts is perceived to be lower risk than investing in the stock or bond markets. Others might use money market funds because they offer a way to access cash quickly, and those approaching retirement commonly begin to switch their pension pot out of riskier equities or bonds in favour of lower risk options.
So, what went so wrong with the FRNs and asset-backed securities last year that caused the losses in the first place?
The problems began at the start of the credit crunch, in August 2007, when the enormous amount of debt consumers and corporates had taken on began to unwind. The institutions providing asset-backed securities were themselves rated AAA, but the underlying holdings – loans, mortgages and other types of debt – were lent to borrowers of a subprime nature. As times became difficult for the borrowers of this debt, defaults on payments began to rise. But the real problem was the lack of confidence in the market, which caused capital values to plummet. Investor confidence in the banks weakened further, as the likes of Northern Rock and Lehman Brothers sought government help or went bust, leading to a severe plummet in FRN values in the autumn of 2008.
Standard Life’s fund was not the only one involved in the more complex cash instruments. In the IMA’s Money Market sector, Threadneedle’s UK Money Securities fund suffered the largest fall. For the year to June 11, 2009, the fund declined by 21.44%, compared with a peer group average gain of 0.7%, according to Morningstar.
Just over a year ago, in April, 2008, the fund sat on £472m in assets but this has since plummeted to £146.3m.
The manager attributes the performance falls to depressed values in FRNs, which amounted to 28.3% of the portfolio at the end of April, but were as high as 40% in September 2007.
However, he defends his decision to invest in FRNs in the first place, because prior to the credit crunch he says they “typically traded at or close to par and were subject to narrow dealing spreads” and that their asset backing was considered a strength.
Many managers perceived them to be low risk and liquid instruments pre-credit crunch.
The M&G High Interest fund was another money market vehicle that has suffered losses in the past year, falling by 5.71%.
Other funds that saw significant losses over the one-year time-frame include F&C Sterling Enhanced Cash (which fell 10.72%), and Prudential’s Maximum Income Trust (which fell 4.62%), which is managed by M&G.
Yet, some funds in the sector managed to beat the peer group average return, despite interest rates radically reducing in those 12 months. At the top of the sector is the Premier UK Money Market fund, which gained 4.07%. The manager says the outperformance is down to holding “plain vanilla, liquid assets” and calling the money curve correctly.
Future categorization:
The proposal is to leave the Money Market sector unchanged, but create a new sector with a “cash-like” definition – funds here will not be “no risk” as they are still exposed to credit and liquidity risk, but they will be lower risk than those funds that invest in other money market instruments. However, the ABI did express a concern that there is a possibility that the returns may not exceed the charges levied, especially in a low interest rate environment.
Nonetheless, the new sector name will either be Capital Stability Fund or Treasury and Deposit Fund.
The IMA also released a statement to say it is reviewing its Money Market sector to coincide with what is happening at a European level, as well as the ABI’s review, and is considering whether to add a “cash like” sector.
The IMA, says this will harmonise the sectors alongside the ABI’s and ensure customers understand what they are buying. However, there are only a small number of funds in the sector (32) and this will be considered in the review, which the Performance Category and Review Committee (PCRC) is likely to conclude in the summer.
