Cash funds reap Euro benefit
At the end of 1998 I was putting together a business plan for the ubiquitous euro money market fund. As part of that review I had talked to number of market professionals and clients to gain an understanding of what opportunities the introduction of the euro would create. Opinions were pretty evenly split between those of the product providers, who not suprisingly were very bullish, and those of the clients who were less so. Of the clients it was the multinationals and in particular the US multinationals who were the most bullish and the European groups who were the most bearish.
So who was right? Well the diplomatic answer is everyone.
January 1999 saw a rush from the large and small money market fund providers to launch euro funds. Buoyed by this euro-phoria, a number of new providers entered the market. Why were fund management companies so bullish? The answer was mainly cost. The cost of running money market funds for the European market had been dramatically reduced. No longer did you have to run a dozen small costly money market funds to cover Europe, one would suffice. Distribution costs were also reduced, which has encouraged more groups to look at distributing institutional money market funds in Europe.
From an investment perspective the funds were able to invest in a more diverse and liquid range of money market instruments as the markets consolidated under one currency banner.
Have clients purchased these funds? Figures are hard to come by. But the story appears to be mixed. Large groups such as JP Morgan, Goldman Sachs and Fidelity have performed well. JP Morgan now has over E1bn in its euro money market funds. Other less well known groups and groups without an established distribution base have done less well. Figures from Moody’s investor services show that the euro assets in money market funds they rate stands at more than $4bn (E3.75bn). As Moody’s rate only a fraction of the euro funds in the market it is clear that clients are buying these funds
It was mentioned earlier that the bears and the bulls were both right. The bears would point out that although there have been some successes sales have not been as high as forecast. One of the main reasons for this has been the comparative weakness of the euro in the foreign exchange markets.
A US investor investing in a euro fund in January 1999 would have seen their investment drop by 14% in dollar terms by the end of June 1999. There has therefore not been a high demand from investors to hold the euro. Another factor that has inhibited growth has been cut-off times. The movement of cash balances took a giant step forward in January. The establishment of TARGET meant that in theory euro cash balances could be moved same day up to very late in the day. However where can that money be invested? Custodians and banks often use money market funds as late day cash sweep vehicles and traditionally offer cut - off times close to money movement cut off times. But in the case of the euro this has not been possible. Cedel and Euroclear still do not move money market securities on a same day basis. This is changing in the autumn but until then euro money market funds will offer cut off times of around midday.
The money markets of Europe are changing. The change is a slow but a fundamental one. With a single currency, money management in Europe is about to enter a mature growth cycle. This maturity brings with it the questioning of previously unquestioned practices. Bank disintermediation is beginning. Finance can now be raised through the issue of bonds and commercial paper, rather than bank loans. Cash management is no longer complicated by currency exposure. Bank mergers coupled with the need to become more competitive, are challenging the traditional bank/client relationships. Pan-European mergers, cross border challenges to their home market and the need to compete to survive are forcing banks to consider their core businesses and ask whether they should be in the low margin, expensive, short term bank deposit business at all.
This is excellent news for money market funds. An active short dated capital market is essential if money market funds are to supply liquidity to their investors. High yielding, secure money market funds that offer instant liquidity and a high degree of customer service are attractive to the corporate or pension fund fed up with bank deposits. Banks themselves see money market funds as a solution. A recent survey estimated that US banks now sweep $250bn into money market funds.
However, education as to what money market funds are, their risks and how they should be used still remain the main barrier to development in Europe. Most fund groups realise this is an issue to tackle as an industry. In recent months 25 groups have got together to discuss topics such as yield standardisation, market education and government and regulatory lobbying. Some of the less contentious issues such as yield standardisation have been agreed and should be implemented over the coming months. Other issues such as market education and lobbying are more complex and are still under discussion.
In conclusion, the introduction of the euro has been a successful event for the money fund industry. However, this success has not been evenly shared. It remains to be seen whether this relatively new industry will be able to support the growing number of providers entering this market or, as like the US there will be a consolidation of business among the top dozen providers.
The potential for those groups that perservere and get it right is huge. Europe’s money markets are larger than the US. Europe currently has roughly $30bn in institutional money market funds; the USA has over $600bn.
Peter Knight is head of institutional money market funds at JP Morgan Investment Management in London