NEW YORK, Oct 14 (IFR) - Enhanced cash funds are rolling out
again in new forms, as investors looking for extra yield amid
the money markets overhaul start to embrace an asset class with
a checkered past.
With the advent of SEC money market reforms that came into
effect on Friday, so-called prime funds - once the go-to place
to boost returns on cash - have fallen out of favor.
And as more than US$1trn has left prime funds so far this
year, short-term bond funds - essentially enhanced cash funds
with a new name - are catching the eyes of investors.
The funds, often privately managed, offer potentially better
yields while not being bound by the new regulations.
But they also carry many of the same risks as their
predecessors, which bruised so many investors in the financial
crisis - even when bearing Triple A credit ratings.
Many analysts say the lack of regulatory oversight, and the
possibility of an extremely wide range of credit quality in the
portfolios, should give investors pause.
"[Short-term funds] lack standardization and their risk
parameters are varied," Roger Merritt, an analyst at Fitch, told
"So there is need for more scrutiny when investing in such
The flood of money from prime funds was prompted by the new
requirement that net asset values, previously kept steady at
US$1, now float and are marked to market each day.
And while much of the money leaving the prime space has been
flowing to government funds so far, investors are likely to find
little joy in their returns.
"The hope is that government money market fund yields would
increase with all this money flowing into them, but that is not
going to happen," said Jerome Schneider, head of short-term
portfolio management at PIMCO.
"Investors in such funds are going to be faced with anaemic
yields for months and years to come."
That has opened a window for privately run funds that can
hold a wide range of debt: short-term high-grade bonds,
commercial paper, asset-backed paper and even Japanese bills.
Theoretically, such a portfolio could easily outperform the
sovereign space where rates still remain lower for longer.
Large institutional names such as PIMCO have been offering
such funds for several years - and are showing good returns.
PIMCO's enhanced short-maturity active exchange-traded fund,
for example, which began in 2009, has returned 1.48% this year
up to the end of August - easily outperforming Citigroup's
three-month Treasury bill index, which yielded 0.16% over the
"People have to recognize [the prime fund exodus] is a
structural change, then pick an actively managed fund
which can independently assess credit and structural risks,"
"That is the challenge."
But the buyside will have to avoid the mistakes that
wrong-footed pre-crisis investors, who often were not fully
aware of the impact of external influences on their exposures.
Many funds at the time were invested in asset-backed
commercial paper, for example, and had exposure to the imploding
mortgage market, triggering massive unexpected losses.
At the moment, investors appear to be treading more
Short-term corporate bond funds have seen a net inflow of
US$4.41bn so far this year as of October 12, according to Lipper
And money has been concentrated in separate accounts managed
by large funds with a capability to maintain a more globally
diversified portfolio - a sign of the buyside's caution,
according to Schneider.
Some money is also flowing into vehicles that mimic the
characteristics of prime money funds.
Federated Investors, for example, got a Triple A rating from
Fitch for a private money market fund it launched recently that
intends to maintain a US$1 NAV and adhere to the liquidity,
quality, maturity, diversity and disclosure guidelines of
regulated money funds.
It went live on September 22 and has already attracted more
than US$220m in cash, according to Crane Data.
One risk to be accounted for in short-term funds is the
wider variation of maturities in them.
Analysts say prime money funds currently have a weighted
average maturity around four to 20 days; for short-term funds,
it could run from 40 days to as much as three years.
"Investors have to appreciate the added risk," said Sue Ann
Cormack, director of sales for BNY Mellon Fixed Income.
"There is a broad range of average weighted maturities and
some are higher than prime money market funds, which may add
relative risk," she said.
Moreover, some investors believe that, after adjusting to
the new reforms, prime funds will be able to deliver NAVs at
US$1 - or close - and thus attract money back in.
"Some cash managers may prefer to remain invested in prime
funds, motivated by the relative safety rather than just chasing
yield," said Cormack, "especially since the crisis proved to
them that investing in short-term bond funds does pose
"It may be a good time to consider short-term funds. But
investors need to understand the risk that comes with them."
(Reporting by Shankar Ramakrishnan and Natalie Harrison;
Editing by Marc Carnegie, Jack Doran and Matthew Davies)