For four decades, many corporate treasurers successfully employed a hands-off approach to managing the money market funds in their portfolios. However, recent market events revealed the danger in this approach. Like other investments, money market funds must be evaluated to determine how they fit into a firm’s overall risk management strategy.
A money market fund evaluation may include an assessment of a corporation’s needs and risk tolerances, the design of an investment policy, the monitoring of money market fund characteristics, as well as periodic re-evaluation and rebalancing of the firm’s portfolio. In the evaluation process, investors should make good use of the money market fund transparency initiatives recently adopted by the SEC and use holdings information to derive a credit opinion. Further, a user-defined system of reports and alerts may be aided by independent credit research in uncovering potential sources of risk. Finally, investors should view all money market funds to which they have exposure as part of a single portfolio that fits their needs and risk tolerances. In uncertain times, failure to consider a suite of cash investment solutions in addition to money market funds may have adverse consequences, which may include delayed redemptions or, in a worst-case scenario, loss of principal.
Money market mutual funds became a principal institutional cash investment vehicle without many treasury managers giving serious consideration to the risk profiles of the individual funds. Immediately following the Lehman Brothers bankruptcy in 2008, some corporate practitioners admitted that they did not know why they were invested in certain money market funds, and that they needed help scrutinizing their money market fund holdings. A cottage industry of transparency services soon flourished.
We think the most basic question about money market funds is not whether they bring benefits to institutional cash management – they do, in most cases; rather, the question is how can an investor use and benefit from money market funds. For institutions that skipped a step or two in the evaluation process before plunging into money market funds, now may be a good time to rethink this question in the framework of the firms’ overall risk management strategy. One then may adjust money market fund usage to the right risk/return fulcrum point. We call it a “retrofitting” process since most organizations already use money market funds in one way or another.
In this article, we hope to help practitioners identify their needs and risk tolerances, establish investment policy guidelines, identify the key characteristics of money market funds, implement a money market fund monitoring system, and optimize money market fund selection. The specific funds investors choose and the tools they use to make such decisions are choices they will have to make on their own. However, we hope this article will provide food for thought, even if not all readers agree with our philosophy and approach.
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