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October 14, 2012 5:07 am
Mark Twain once said that “reports of my death have been greatly exaggerated”. Similar can be said for money market funds. The viability of Europe’s $1.5tn money market fund sector has been called into question since the advent of the financial crisis.
Concerns initially focused on credit, then liquidity risk, but with the European Central Bank’s decision in July to cut the interest rate on its deposit facility from 25 basis points to zero, making the threat of negative interest rates real, investors are now asking; “how much is it going to cost me to invest in money market funds in future? Why should we continue to use money market funds?”
Within the money fund industry debate is focused on the challenge of ultra low or in some cases negative yield. In the European government money fund sector investor net yield has already fallen below zero. This presents a challenge for sponsors considering which mechanism they should employ within their funds to reflect a potential net negative yield to investors.
The industry has so far considered three solutions: reducing the number of shares investors hold in funds; levelling fees outside a fund’s structure; or closing down funds. The common link between them is the desire to maintain a fund’s constant net asset value (CNAV) of 1.000, for long one of the industry’s most cherished tenets. This focus is wrong. The CNAV approach is too rigid, with the risk of “breaking the buck” seen as the doomsday scenario for investors and leading to the wrong solutions being sought to the wrong problem.
What’s been missing so far is an open and rational debate about what a variable net asset value pricing structure can offer. Calculating a daily mark-to-market valuation can bring greater flexibility and transparency. But a shift away from a CNAV structure is seen by many as unpalatable and the commitment to CNAV runs deep.
In August the US Securities and Exchange Commission – which was touting a variable net asset value approach as a potential solution for its beleaguered money market industry – gave up the fight for reform after coming under unprecedented pressure from providers to maintain the status quo.
While this depth of feeling has not reached European shores, the solutions on offer by asset managers demonstrate concerted commitment to the traditional constant pricing model. However, the European Parliament’s recently published Draft Report on Shadow Banking also contains pressure for funds to move to a VNAV structure.
One misconception about VNAV is the perceived shift away from maintaining a constant net asset value, potentially introducing daily volatility in the NAV. In fact, many proponents of the approach are firmly committed to maintaining this core principle.
After the collapse of Lehman Brothers, certain fund providers such as Aviva Investors took the decision to move their triple-A rated money market funds to a VNAV structure while retaining, as an objective, the goal of providing a stable daily valuation of 1.000.
In addition, there is concern about significant volatility in VNAV funds should there be significant changes in short-term interest rates. Ironically, managers of these structures tend to adopt more conservative investment strategies to mitigate volatility risk.
Many funds restrict the amount of longer-dated securities they invest in, and avoid potentially illiquid assets such as fixed-rate notes, which have proven to be very volatile since the collapse of Lehmans. Calculating a daily mark-to-market valuation requires managers to communicate better to their investors and has given investors greater transparency.
While predictions of the end of the European money market sector are wildly off mark, there is a clear need for the sector to adapt and reform. The solutions being proposed to investors, as fund managers grapple with the issue of negative yields and their fiduciary duties, are comprehensive and considerable in scope.
However, more discussion is needed about the industry’s commitment to CNAV, and whether VNAV is a viable solution that can bring greater transparency, commitment and clarity to the sector.
Colin Cookson is managing director, global liquidity at Aviva Investors
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