Think of the cash investment arena as a darts board. Narrowly defined AAA liquidity funds, the standard money market products, occupy the central “bull’s eye”. Around it, going out in different directions, different enhanced cash products take different approaches to adding risk, limiting liquidity, and increasing potential returns.
The analogy, courtesy of Marc Doman, managing director of Aim Global, shows not only what a range of products are captured by the label ‘enhanced cash’, but also how difficult it is to provide a definition.
Kathryn Kerle, vice president and senior credit officer at Moody’s, says: “It seems to be hard to define; that’s something we are currently struggling with.” In the US, Moody’s has coined the term ‘short-term funds’ to deal with enhanced cash products, and it plans to make this a global designation. US house iMoneyNet, which issued a report into the growing enhanced cash market late last year, splits the arena into three sub-categories: cash-plus, enhanced cash, and ultra-short bond funds.
Enhanced cash products in this wider sense share an ability to “give clients the opportunity to take some additional risk and, obviously, receive a commensurate increase in return,” according to Jonathan Curry, head of European cash management at Barclays Global Investors (BGI).
The majority of money market funds are AAA rated, have a stable net asset value, with low risk and the aim of preserving capital, providing liquidity, and producing some yield. “They are very low risk, they do what they say on the tin, and that’s what some clients are looking for,” says Mr Curry.
But, for clients who want to add risk, and can afford to give up some liquidity, there are various options: taking more duration risk, going further along the credit curve, even looking at structured products.
As figure two shows, a bewildering range of strategies, fee structures, benchmarks and durations fall within the enhanced cash space. And, with this greater complexity, and opportunity, comes a corresponding need for clients to understand exactly what they want and what they are getting.
“There is a greater degree of genericism in the standard money market funds market than in enhanced cash,” says Mr Curry. “You need to know more about the risks that are being taken in that space. The funds are smaller. They obviously offer less liquidity than the traditional funds, and most either trade next day or weekly rather than daily with same day value.”
Institutional investors need to ask, he says: “What additional risks are being taken? Do I understand them? What’s the track record in adding value?”
But, as is often the way with relatively young markets, the need for extra-careful due diligence goes hand-in-hand with a scarcity of information. Performance figures for this market are less helpful than for more traditional ones, where comparisons are straightforwardly of apples with apples.
“You can’t look at five providers and say, ‘They look the best and I will go with them’,” Mr Curry warns. “Because these products are far less generic – you can’t say that, broadly, the risks will be the same.” In order to achieve any useful comparison, he argues, an investor would need to examine risk-adjusted returns – and such figures are not (yet) generally available.
Institutional money market funds have some $1217bn (€1020bn) under management in the US, according to the Institutional Money Market Fund Association (IMMFA). In Europe, IMMFA member funds handle some $250.33bn.
Moving out into the wider arena, iMoneyNet data for the end of September last year puts the total for cash plus, enhanced cash and ultrashort bond portfolios in the US at $492.70bn. For offshore products, the figure is $41.8bn (see figure one).
It is unsurprising that such data as is available is focused almost exclusively on the US market: it is much older. These products have been around in the US for some 25 to 30 years, says Sander Boelen, global head of short-term asset group sales at ABN Amro Asset Management, which manages €6.7bn in liquidity funds and €6.4bn in enhanced cash.
In Europe, the traditional money market fund industry began in the mid-1990s, according to Mr Curry, when the US providers started looking overseas. The enhanced cash space began “slightly later” with the first funds “around the late-1990s, and the bulk in the last two to three years”.
Enhanced cash management is an expanding market, and likely to remain so. This is evident both from the increasing interest of institutions, and from the number of providers keen to get in on the act.
Peter Crane, vice president and managing editor at iMoneyNet, attributes a slight blip in the growth of the industry in the US last Autumn to rising interest rates, and expects it to be temporary.
Consultancy Watson Wyatt expects enhanced cash funds to be “a significant area of growth over the next few years”, with demand coming particularly from the adoption of cash-backed derivative strategies and defined contribution schemes.
According to Watson Wyatt, the majority of big players in the liquidity fund market have now launched enhanced cash type products, while such managers are also likely to have a number of bespoke segregated mandates that could be classed as enhanced cash.
Moody’s has seen an increase in enhanced cash funds requiring ratings, which Ms Kerle attributes mostly to asset management firms starting off with straightforward euro, sterling and dollar liquidity funds, then adding enhanced cash to the line up as a natural next step. “My guess is that they are appealing to investors they know from the last round of funds, but who have some cash they don’t need immediate access to,” she adds.
Aim Global, a money market fund specialist with $55bn in its products and a 25-year track record, is a case in point. It is “actively looking” to develop a range of enhanced cash products, hopefully by the end of the year, according to Mr Doman.
ABN Amro’s Interest Growth Fund grew from €200m to €1bn in the 11 months to December, according to Mr Boelen, while the model-driven Euro Plus fund, launched in 2004, has collected €100m. Northern Trust has launched US dollar enhanced and euro short-bond strategies over the past two years, driven by demand from individual clients.
BGI runs two enhanced cash products: Cash Plus, launched in 1998, which has £3.4bn in its sterling version, €1.9bn in the Euro Plus and $940m in the Dollar Plus; and an asset-backed product launched in 2001, now running £225m, €85m and $520m in the different currencies.
Enhanced cash products, says Mr Boelen, “fill the gap between long-term investing and liquidity funds”. It is, then, perhaps no surprise that they should be attracting such “tremendous interest”. But if the cash management arena really is a darts board, then the rules have changed, because shrewd institutional investors want to hit targets across the board, and can’t assume that getting everything in the centre will win them the game.
THE COMBINATION APPROACH
Enhanced cash funds and money market funds are not mutually exclusive alternatives for institutional investors. Rather, they belong together in a ‘tiered’ or ‘combination’ approach to allocating cash.
“There is not one holy grail,” says Sander Boelen, global head of short-term asset management group sales at ABN Amro Asset Management. “Even with cash, there is a portfolio approach: one month, up to three months, up to nine months, with different products giving a much higher return than you typically receive on cash.”
Nor is this a straightforward case of institutions jeopardising their security and liquidity requirements by abandoning money market funds for their riskier cousins. Wayne Bowers, director of fixed income, Northern Trust Global Investments says: “Perhaps if they looked at their cash management, clients would find that it falls into two components – a frictional component that is needed on a day-to-day basis, and stable cash balances.” The shrewd allocator will be able to identify these components, putting the former into money market funds, the rest in enhanced cash products.
ABN Amro takes this a step further again, according to Mr Boelen, and has exploited its position as both bank and asset manager to set up “liquidity advisory desks” in Amsterdam, London, Chicago and Singapore since early 2005. This, Mr Boelen adds, “combines cash and enhanced cash funds with banking products”.
The tendency so far, particularly in continental Europe, has been to treat all one’s cash in the same way, putting it all into one basket or the other. To complicate matters still further, European markets often differ as to the nature of the funds described as money market. “In France, money market funds may in effect be in enhanced cash as far as the UK or the US are concerned,” Mr Bowers adds. “French money market funds tend to be short bond funds with an interest-rate swap overlay that reduces average life.”
The US is more sophisticated in terms of combining a range of strategies. Mr Bowers explains: “Institutions tend to have a better spread of cash management over different products. They tend to use short bond and enhanced cash products more effectively.”
The UK, he adds, “marries both marketplaces. There is a move towards enhanced cash structures but it needs to be driven by more appropriate allocation to cash as a whole, rather than just using frictional cash in enhanced cash funds.”
