It is often widely assumed in financial circles that as dawn breaks on an innovation, US managers will be the first to capitalise on it and will pretty much dominate the market. This could well be the case with institutional money market funds, but the products themselves may need to change before they find widespread success in Europe.
The current players in the UK market, the testing ground" for European institutional money market funds, are certainly dominated by US managers such as Chase, Citibank, Northern Trust and AIM Global Advisors, with investment giant Fid-elity leading the field with $1bn under management in its Dublin-domiciled fund. Their dominance in the market has stemmed from retaining the fund structure used back in the US, which offers investors a safer alternative to a bank deposit with a high level of liquidity, fairly competitive returns and a stable net asset value (NAV). But the real selling point to date in the UK has been the security aspect, following the Barings collapse. All funds are triple-A rated, either by Standard & Poor's or Moody's, essentially removing investors' risk of losing their money (see box), which could happen if their bank defaulted.
The fact that most if not all US pro-viders are eyeing continental Europe is not surprising. Sensing this interest, local providers have been launching funds of their own, notably Rothschild Asset Management, ABN Am-ro and NatWest Gartmore, with Soc Gen gearing up and with Jupiter Asset Management in discussions with Caisse Centrale de Rescomptes (CCR) about becoming a possible future provider. What is surprising, however, is that all these funds have taken on the US structure, demonstrating a high level of confidence in the success of the US approach in Europe. This is surprising only be-cause the current habits of European investors seem to be anything but conducive to the funds which these managers are planning to offer them.
The primary difference between US and European money market funds is the motivational factor behind using them. In the UK, it has evidently proved to be security-driven, with funds maintaining a stable NAV ensuring a certainty of price. Throughout the rest of Europe, the drive is for extra returns on cash investment: 'How much can the cash earn?' Consequently most money market funds on the continent are accumulative, the idea being that the fund's value increases on a daily basis and whose interest earned can be used to offset tax liabilities. Also, due to the illiquidity of many of the European markets, extra risk needs to be taken to obtain an acceptable return. The security factor is by no means left by the wayside, but the continental funds will not sacrifice the yield for top-level security. US funds, on the other hand, will not sacrifice security for yield.
By launching US-style funds into Europe, institutional money market fund providers would be viewing the continent in the same context as the UK. That is to say, they would be assuming the same level of distrust in the banks, and the desire for a high level of security on cash investments.
"It's a cross-border product," as-serts Anthony Myers, managing dir-ector of AIM Global Advisors in London, which manages $400m in its US dollar fund and approximately £200m ($320m) in its sterling fund. "Certainly in France, some of the banks have been through some very tough times, tougher I think than the UK banks have been through. So I think the same driver is there for institutions to protect their cash by investing it as opposed to depositing it."
The banks may have paved the way for money market funds in France but it was more of a desire for better returns than a fear of bank failure. As banks were not allowed to pay interest on current accounts, money market funds offered significant fiscal advantages.
The triple-A rating has been an at-tribute US providers have found es-sential to market to UK investors. As a result, the yield levels are restricted as investments cannot be so risky as to jeopardise that rating. But yield is the area in which continental investors seem most interested.
Commerzbank holds DM10bn ($5.8bn) in institutional money market funds, with 95% of assets sourced from French institutions, managed by CCR in France. The bank's retail money market funds are triple-A rated by Moody's, but, says Peter König, head of product development at Commerzbank in Frankfurt, the institutional fund has remained unrated as "there has been no need, no request from the clients".
Equally, the funds run by DWS in Frankfurt are unrated as, the demands of the investor, says Eckhard Berg-mann, head of marketing, are not for the rating but the yield. He even goes so far as to suggest that a rating would only serve to mislead the investor. "It seems to tell the people that this is the best quality, when what they expect is performance in the fund and the rating doesn't say anything about that."
Fabrice Vallat, client consulting at Clariden Bank in Zurich, views a triple-A rating as too restrictive for both its private and institutional clients. "We would have to change our investment guidelines - if you want to invest 90% of the fund into triple-A instruments it means that you have to accept lower yield and I am not sure that most of the investors would understand that."
The same situation applies to the Nordic regions. ABN Amro-owned Alfred Berg's money market funds in Helsinki are solely aimed at the institutional market, notably Finland's pension schemes, as are most of the other major Finnish banks' funds. Alfred Berg's fund currently holds FIM1.1bn ($211m) and also runs money market funds denominated in local currencies in Norway, Sweden and Denmark applying the same no-rating principle.
"In Finland, none of the funds are rated directly but various funds have various limits within their rules as to which instruments they may use," says Tim Hermansson, managing direct-or, adding, "If you obey the rules of the fund, there isn't really much risk in it."
US funds impose a 60-day maturity limit on securities to eliminate the risk of fluctuating interest rates, but again the continental investment patterns point to a very different level of importance given to risk management, says S&P's Bradley. "In Italy and in Spain, money market funds can and do invest in bonds and in Italy it tends to be up to 18 months' maturity remaining on the instrument. In Spain, I think it is up to three years."
For US-style money market funds to work in Europe, many factors need to change first. These include greater liquidity in the markets and further evolution of the repo markets, not to mention a 180-degree turnaround in investor attitudes towards cash, so that they come to view security as paramount and yield as secondary. This is not likely in the short term. But the advent of the euro might pave the way for a unified product which combines the best of both US- and European-style products. And as Jeroen Tielman, head of product development at ABN Amro in Amsterdam points out, there will inevitably be a market for the US pro-ducts, but neither the US nor the European managers should ignore the alternatives if they want to secure a wider client base. "The US-style type of money market fund is clearly a widely recognised concept. But I be-lieve that there can certainly be room for other types of products, which less emphasise the security and liquidity and could offer enhanced return.""
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