LONDON, July 24: A year after the credit crunch sent money markets into spasms, risk-averse investors have learned that juicy yields and safety do not coexist and have become increasingly discriminating within the money funds universe.

During years of easy credit and abundant liquidity, many asset managers invested in various high-yielding money market funds, believing they had offered the same safety of cash but with juicy additional basis points.

On the surface, the risk profile of these “enhanced” funds did seem low as easy market volatility masked what transpired to be the risky nature of their investment in structured products such as Asset Backed Commercial Paper (ABCP).

However, the unravelling of the 2001-2007 credit boom was a game changer for many market funds. As troubles in US subprime mortgages posed severe questions about the credit quality of top-rated repackaged securitised assets, liquidity evaporated in these markets and money funds were forced to dive for cover.

“The enhanced money market funds industry has experienced huge outflows. There have been dramatic shifts in terms of liquidity,” said Isabelle Demoliere, head of European short term asset group at Fortis Investments UK.

“(Before the crisis,) every market participant was running out to find yield and forgetting about risks. There was so much liquidity in the market. They thought, how can liquidity vanish just in one day?” But liquidity did vanish rapidly. As a result, in Europe, at least a dozen enhanced money market funds were suspended or liquidated after their net asset value fell up to 20 per cent in some cases, according to Fitch Ratings.

“Enhanced yield funds (are) probably the worst casualty,” said Abisodun Soetan, associate director of fund and asset manager rating group at Fitch.

“The reason they struggled so much since the crisis is there was a mismatch between investor and fund objectives... Investors could’ve asked the question on how and where these yields have been enhanced.” Conservative funds benefited at the expense of enhanced cousins. Fitch reckons Europe’s top-rated money funds grew about 40 percent since June 2007 into a 400 billion euros industry.

Boom and bust

The investor exodus from money funds and the closure of ABCP and other structured products the cash generating machines of the so-called shadow banking system of conduits and structured vehicles went to the heart of the one-year-old crisis.

Banks, who had used these vehicles as a key funding source, rushed to interbank money markets to secure cash.

The panic dash for cash was aggravated by banks hoarding money as a contingency for credit-related losses, driving up wholesale funding costs to levels not seen since the 1990s.

The interbank lending stress has lingered for months as banks desperately needed funds to shore up balance sheets after writing down hundreds of billions of dollars.—Reuters