The money market fund scene has grown quieter again, after last winter’s excitement generated by the switch to the euro. But there are signs that money market funds will find a new role to play, as pension funds look to improve efficiency and generate higher yields.
Although cash management products are out there on the market, most pension funds strive to remain fully invested. “All of our clients are benchmarked against fixed income benchmarks,” says Robert Marsden, senior consultant on fixed income manager research at William Mercer in London. “Because of the nature of pension funds with no cash in the benchmark, any cash is temporary. Therefore it does not make a lot of sense to outsource it.” Most pension funds tend to manage their short-term liquidity through term deposits or short-term paper, he says.
Hans Dieter Ohlragge at IBM Pensionskasse in Germany agrees that money market funds are not likely to play a substantial role in pension fund management. “They could only play a minor role. Normally pension funds are oriented to long-term investment.”
Nonetheless all managers hold cash reserves, and some consultants are becoming more positive about the use of money market funds. “There is a certain percentage of most pension funds that would be appropriate for money market funds,” says Anders Lindell at IPM Informed Portfolio Management in Sweden. “It is a problem that you need to stand on your toes to manage all your cash holdings. It is quite a big problem and a lot of people are focusing on this.”
Lindell sees an opening for the greater use of money market funds. They may stand to benefit from the inexorable trend towards a greater use of index funds. “There is a clear trend among our more advanced clients to reshuffle portfolios, using index funds more,” he says. He estimated that around 80%–90% of the total fund will be managed in index funds, leaving the remaining 10%–20% for the fund manager to deploy in a more adventurous way. “They can play around with a small portion,” said Lindell.
Money market funds could be the beneficiaries of this smaller segment of the fund. “Money market funds will probably receive slightly more and bigger mandates than before,” Lindell says, because fund managers cannot leave the cash floating around. “Money market funds solve that problem,” he suggests.
Both consultants and and managers agree that, with money market funds, there are fewer distinguishing characteristics than with either equity or fixed income funds. The credit rating is not a distinguishing factor – all the major money market funds boast AAA ratings from either Moody’s or Standard and Poor’s. “These ratings serve a purpose,” says Justin Pryor, assistant director, treasury, at Leopold Joseph. “They are in many ways similar and are not looked at on an individual basis.” The fee structures of the various money market funds are also similar.
Consultants stress that those funds choosing to deploy their cash in money market funds do their due diligence just as they would when selecting any other manager. “It is normal to do a full survey of the funds on offer,” says Ohlragge at IBM Pensionskasse. “You have to apply the same criteria as for an equity manager,” says Marsden at William M Mercer. “You look at such issues as stability and the nature of the people involved in managing the fund.” Size is one distinguishing factor, as it is more efficient to manage money market funds with sufficient volume.
“In the Nordic region, the focus is most on consistency in investment philosophy,” says Lindell at IPM. “Many pension funds also value a prior relation to the fund manager.” It also makes sense to be wary of money market fund managers who promote alternative strategies for managing their funds. Most consultants are skeptical about funds that promise to improve yield, trying to beat the indices or outsmart the market. “For certain clients these funds may make sense, but they are not really efficient. It is better to look for improved returns with your primary managers or your overlay strategies,” says Lindell.
However, it may be possible to obtain higher yields without introducing an element of risk. “Cash is a defensive sector. You want to improve yield without risking capital,” maintains Pryor at Leopold Joseph.