A. Recent market turmoil uncovered rising systemic risks among money market funds:
- Regulatory rules failed to adequately address investment risks
- Defending the constant $1 share value became more difficult
- Money funds as commingled vehicles have inherent drawbacks
B. Key factors in money market fund selections:
- Focus on the wherewithal of the funds’ sponsors
- Shun funds overly exposed to derivatives and illiquid securities
- Focus on long-term fund performance
- Look beyond fund credit ratings
C. Decisions in the real world:
- Risk of investing in Treasury money funds has increased
- Investors must be vigilant in money fund due diligence as in other investments
- Combining money fund and separate account investing may be prudent risk management
In early spring of 2008 we witnessed corporate treasurers stampede toward prime money market funds in the midst of accelerating credit concerns. Then, in May 2008, we issued a research paper mentioning that some funds, long proclaimed to be safe and stable investment vehicles, may not, in fact, live up to such a reputation. The premise was that the money fund industry was then (and remains today) rife with systemic risks not unlike that of the auction rate securities market.
The bankruptcy filings of Lehman Brothers and the resulting “buck-breaking” event of the Reserve Primary Fund kicked off a wave of swaps by cash investors from prime money funds to government funds and insured bank deposits. Prime funds saw a staggering outflow of $320 billion in the first four days after the Lehman bankruptcy alone. Investor retrenchment from prime funds, in turn, effectively shut down the commercial paper market and led to the unconventional liquidity measures by the Federal Reserve Board to prop up money markets.
What are the systemic risks in money funds? What are the factors that caused the mass reversal of public confidence? Are there risks present in the post-Treasury guarantee period? How does an institutional cash investor dissect the myriad of money fund offerings? Is investing in money funds really safe? What are the other viable options? Many of these questions are not only valid, but crucial for stakeholders in today’s environment.
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