Money Market Madness? Even in a market haven, investors can't feel too safe
Christopher O'Leary (christopher.oleary@tfn.com). The Investment Dealers' Digest
: IDD. New York: Apr 15, 2002. pg. 1
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Abstract (Document Summary)
Money market mutual funds have gained a reputation over the last year as the capital
markets' escape hatch, as investors bruised by volatility in the securities markets have
poured into the funds in search of stability. Yet at least one fund manager now wonders
if investors are aware that some money market funds themselves could face serious
risks under certain circumstances. In particular, officials at the hyper-conservative
Reserve Funds express concern that too many funds are holding large amounts of
commercial paper and collateralized debt obligations, both of which have at least the
potential of high default rates and diminishing liquidity. The concern is that investors will
remain unaware of any problems until a major headline event occurs, like another Enron
Corp. scandal, and then overreact, thus causing damage to the overall market.
Full Text (852 words)
Copyright Thomson Financial Services Inc. Apr 15, 2002
Money market mutual funds have gained a reputation over the last year as the capital
markets' escape hatch, as investors bruised by volatility in the securities markets have
poured into the funds in search of stability. Yet at least one fund manager now wonders
if investors are aware that some money market funds themselves could face serious
risks under certain circumstances.
In particular, officials at the hyper-conservative Reserve Funds express concern that too
many funds are holding large amounts of commercial paper and collateralized debt
obligations, both of which have at least the potential of high default rates and diminishing
liquidity. The concern is that investors will remain unaware of any problems until a major
headline event occurs, like another Enron Corp. scandal, and then overreact, thus
causing damage to the overall market.
Compared with most Tier 1-rated prime funds, "we are extremely rare in that we shun all
corporate debt obligations. We adhere to our founding principle, which is that liquidity
and capital preservation supercede returns," said Mike Sheridan, director and senior
portfolio manager at the Reserve Funds. The possibly higher yields to be gained by
holding CP, for example, is simply not worth the risk, Sheridan said, so Reserve puts its
money solely in such sectors as government obligations and Tier 1-rated bank
certificates. "One of our principal concerns is that the market did not take into account
the risk factors inherent in CDOs," Sheridan added.
Other fund mangers disagree, naturally, noting that a diet of pure government bonds, for
example, is entirely too bland for many investors. One investor said that while there are
discouraging signs in the CP market of late, the overall market still offers much better
security than investing in stocks right now, for example.
Reserve's brand of conservatism, however, could increase in appeal should investors
begin to seriously doubt the investment strategy of their money market funds. Money
market players have a lot of investments to make-last year about $400 billion in inflows
entered the market, creating an overall $2.2 trillion market volume. The increase was the
result of a massive number of refugees fleeing less hospitable market sectors. While
most money market players believe 2002 will not have as many inflows, the amount of
capital in the market is still going to be massive.
Yet the strategies of many money market players-investing in CP or top-rated CDOscould have pitfalls. For one, the CP market appears to be spiraling downward, as many
issuers that regularly tapped the market have been shut out of all short-term credit
markets, thus depriving CP players of the generous liquidity that has long been
associated with the product. Analysts predict the CP market could achieve a ten-year
low point in issuance volume this year.
Money market funds are required by law to have the great majority of their holdings
(roughly 95%) in securities rated Tier 1. The problem is that many former Tier 1 issuers,
including such former market stalwarts at Pacific Gas & Electric Corp. and Qwest
Communications International Inc., have lost their status during the last year, thus
diminishing overall CP issuance and possibly increasing illiquidity.
"There's definitely been a dearth of high quality corporate paper, and it's led to managers
looking for opportunities in other areas," said Katherine Lynch, an associate director at
Fitch Inc., noting that as a result, there has been an increased interest in asset-backed
commercial paper by fund managers. "Some of the products fund managers are now
considering in lieu of corporate paper, such as some of the newer short-term structured
products, are not necessarily riskier, but require a different type of risk analysis."
Even the largest current issuer of commercial paper, the General Electric Co., could be
in trouble. Moody's Investors Service noted recently that of GE's roughly $127 billion in
outstanding short- term debt, committed bank lines support only roughly $33 billion. This
exposes GE to substantial funding risk, Moody's analysts noted. In response, GE
officials have said they intend to increase their committed bank lines to $50 billion.
The problem, some market critics say, is that even the most well- regarded or dominant
company could suddenly take a turn for the worse, which means that most of the
corporate bond market is a minefield for issuers wary of credit deterioration.
What is further troubling to these critics is that a number of money market funds,
including Putnam Investments and USAA, have recently dropped their default insurance,
which will mean higher risks for investors in these funds. Such insurance ensured that
funds would get paid back if an investment cratered. The primary reason money market
players are dumping their insurance is that they can't afford it anymore-the wave of
defaults in the last two years has jacked up premium prices by as much as 200%.
There are signs that investors are pushing for security over the quest for higher yield. "In
general the tone has changed very much [over the last year] from purely a yield
perspective to a value approach, where the goal is to achieve the best balance of yield
and portfolio quality," said Bruce Bent, Reserve Funds president.