Abil proves Money Market funds aren’t risk free, still best place to park cash
On of my early jobs in journalism was at Finance Week. My 2.5% ownership of the business was taken back when I left, but they did give me the first 12 bound editions of the publication. Over the weekend I was having a read at some of the articles I wrote for the mag in late 1981, among them was one on Money Market funds – a concept taking the US by storm but which the local banks (and the SARB) said would never be allowed to happen here. Millions of consumers – and the subject of this interview, Andrew Canter – are delighted it has. Today SA money market funds hold a quarter of a trillion rand of savings, delivering a far higher interest rate than paid for similar on-demand deposits with banks. Over the past month, however, Money Market funds have come in for stick. In the wake of Abil's wipeout, the fact they also carry risk has been well illustrated. For the first time, the perception that cash put into these vehicles is guaranteed was shown to be a fallacy. But Money Market funds remain extremely safe investments, holding most of their value even after a disaster of Abil proportions. – AH
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ALEC HOGG: Andrew Canter, who is the Chief Investment Officer at Futuregrowth, joins us now. Andrew, in the wake of the Abil disaster, there's been quite a lot of comment on various websites about retail investors losing money. Getting letters sent to them from the asset management companies to say that the money they put into a Money Market Fund is not 100 percent theirs anymore. It is something that happened in the United States some years ago. Let's maybe begin with this term 'breaking the buck'. What does that mean?
ANDREW CANTER: Well, let's go to first principles. Generally, when we talk about Money Market Funds, investors tend to think of them as extremely low-risk, if not zero-risk investments. But in fact, they've always had risks. Inside a Money Market Fund is a range of investments. A fund manager will buy a whole bunch of different bank NCDs, sometimes they'll buy some short-dated debt instrument issued by large corporations and other financial companies, so you end up with a diversified portfolio. At any given time – let's say that 50 different borrowers are represented in a fund – any one of those can go bust and you can lose part of the capital. Now, these are short-dated instruments by law, and they are usually high-credit quality – by regulation, too – so your chances of losing money are very small.
Consequently, the daily unit price is usually held at R1 per unit or R1 per share, and you just get daily accrual. What happens when one of those underlying issuers (in this case, Abil) goes bust? If you're sitting on a portfolio that has five percent exposure to African Bank, and African Bank closes its doors and you lose that money, you shouldn't really be maintaining the price at R1 per unit for the fund because you just lost five cents per share. You should be breaking the buck – you should be pricing the units at 95 cents per share and not at R1 per share.
ALEC HOGG: In my previous company, we had a big deposit with a Money Market Fund and despite our efforts were not able to get a guarantee on the capital of that fund. Now I see why.
ANDREW CANTER: Well, that's right. It's an investment and in all investments, it's risk and return. What is the risk you take in a Money Market Fund? You have a diversified portfolio of short-dated credits. Any one of them can get into trouble on any given day. As we saw with Abil, you may have had five percent exposure but in fact, by the time the Reserve Bank is through, you're going to get back 90 cents on the Rand so in fact, your loss wasn't the full five percent. It was only point-five percent. So it's not a crisis. With a unit price, you would have lost point-five percent of the capital of the fund. On the other hand, if you were an equity fund holding five percent of Abil – holding Abil shares – you've just lost five percent, so again, risk goes with reward. Short-dated debt instruments are lower risk than equity investments or pressure investments. The fact that retail investors are told that Money Market Funds are risk-free is a little bit delusional. There's always a bit of risk.
ALEC HOGG: In this case, if you have R1m invested in your Money Market Fund, you don't like hearing that R5 000 of it has disappeared.
ANDREW CANTER: Well, this is true, but on the other hand, if you had R1m and you put it directly into an NCD or a bank deposit, the possibility is that when Abil closed doors, you (a) could have lost all of that money in the absence of the Reserve Bank coming in. You could have lost your entire R1m, because it's not a diversified portfolio or (b) with the Reserve Bank stepping in, you could have lost a full ten percent of your R1m (R100 000). In your Money Market Fund, you only lost point-five percent or R5 000. You see, the diversified portfolio is a buffer. Lastly, its worth more by putting it into a Money Market Fund while you pay a manager some fees, you're probably getting a higher yield because your asset manager is able to negotiate higher interest rates from the banks they put money with, so you do get a slightly higher return. You do get a more diversified portfolio and so that's the trade-off. There is risk, but it's not as risky as putting all of your eggs in one basket.
ALEC HOGG: Andrew, if it's only that small: point-five percent, as you've explained in this example, wouldn't it then be easier (for the fund manager) just to carry that yield over the year?
ANDREW CANTER: Yes, that's the problem. It seems to make sense – the fact that the FSB will allow a fund manager to offset a day or two's interest accrued on a fund with a capital loss, so you don't have to actually break the buck. The fact of the matter is these are open-ended funds. Clients can buy and sell units every day. If Abil closed its doors on Friday and everybody knows it, and you know that the unit price of your unit trust hasn't dropped, everybody's going to seek to withdraw their money on Monday as soon as they can. While your logic is true that over the course of a year, your interest will accrue and offset that loss, the fact is everybody will run out of the fund on Monday. With an open-ended fund, it allows people to trade units on a daily basis. You have to market the assets and you have to market the unit price, otherwise it's prejudicial either to hold, or to remain.
ALEC HOGG: The Americans brought in something called floating net asset value. How exactly does that work?
ANDREW CANTER: In a classic Money Market Fund, they always hold the unit price at R1 per share (or $1 per share in the U.S.). What we realised in the financial crisis and what we realise now in the Abil crisis, is that sometimes you can't (or you shouldn't) hold the price at R1 per share. A floating NAV would be something that allows the price – every day – to go up or down for minor changes in the capital value fund. In the normal course of events, the Money Market Fund would then trade between 99.85 cents and, say, R1.015 cents. You wouldn't even notice it. The flow would be insignificant in everybody's daily lives until there was a credit event – until there was some default or an underlying borrower in the Fund. Then your unit price might drop to 98 cents or 97.5 cents, but that allows the mechanisms to operate in a seamless, flowing way, rather than what we've seen in the past week where suddenly it's 'oh, my gosh. I don't know what the price of my units are.
They look like R1, but I can't get out' or nobody's really clear on what's happening, because the price isn't changing, and so you don't really know how to react. The floating NAV is a cleaner mechanism to transmit the message that there is risk in the investment, that it isn't guaranteed, that the merit of the product is sound, but that the price can change.
ALEC HOGG: Is that likely to be introduced here?
ANDREW CANTER: What they've done in the US is they've introduced a floating NAV only for institutional targeted funds – funds that are sold to institutional investors – and not for retail investors. I think it's a very poor solution. I think it remains delusional that that there's no risk that their price is always R1.00/$1.00 per share and I do think a floating NAV should be introduced globally, and in South Africa as well. There are various marketing reasons. Salespeople don't like it. They like to pretend that it's like investing through the bank account. You put R1.00 in the bank. It's R1.00 today, it's R1.00 tomorrow, and it doesn't change (unless the bank goes bust). The salespeople of Money Market Funds like to pretend it's always going to be R1.00 per unit and they don't have an issue with that but actually, any asset manager worth his salt on the investment side, knows that assets change in value by a little bit. Every day, they can go up or down and you really should bring that through as truth.
ALEC HOGG: You mentioned a little earlier that the Financial Services Board has allowed Money Market Funds to take one day's interest to offset the capital losses. In most instances, is that going to be sufficient?
ANDREW CANTER: Firstly, I may have misspoken. I believe that the write-downs on Abil were taken on the Monday after that weekend when the SAAB stepped in, so I think it was three days of accrued interest that the funds could use to offset the actual write-down on the Abil senior debt they took, and in many cases, that was enough to cover it. You lost yield, but you didn't lose capital. The other choice that was made – and this is really extraordinary – is that rather than actually break the buck and allow the price to move down to say, 99 cents or 98.5 cents is they didn't break the buck. They merely reduced the number of unit holdings so yes, you might have had 1000 units at R1.00 per unit and today, you have 998.5 units at R1.00 per unit. We therefore didn't change the unit price; we just changed the number of units. It's a rather tricky way to accomplish the same thing without breaking the buck.
ALEC HOGG: But people aren't stupid. For instance, I've been looking at Fin24. There were some concerns there from people at Absa who'd found that money had disappeared out of their Money Market Fund and they didn't really understand why. The marketing guys want to keep the illusion that this is safe but in reality, there is a risk attached.
ANDREW CANTER: I think you've hit the nail on the head. My view is that in any investment fund, there are risks. Sometimes the assets go up and sometimes they go down. To maintain a fixed price is delusional and they should have just changed the unit price. The mechanisms weren't easily in place to do that on a wide scale, across the industry. I do think that as we look back in three years' time, the illusion that they never broke the buck will be maintained, where you, I, and those unit holders who lost units on that day will know that they lost money, but that will be hidden to posterity. It's a terrible thing, I think.
ALEC HOGG: There's a lot of money tied up in Money Market Funds as well – R270bn by the last count, so Abil's demise in the initial instance was thought only to have affected those who invested directly in the shares, but that isn't the case.
ANDREW CANTER: We mustn't lose sight of the role of the Money Market industry. What I said earlier was Money Market Funds invest in a wide range of bank paper, of short-dated commercial paper from corporates, and they do create a competitive force against the banks having a monopoly and oligopoly on lending so they're a positive factor. It's a way for investors to disintermediate the banks and make direct loans to corporates through their asset manager. That's a good thing for the economy. It creates a more efficient capital market. They are diverse funds, so you're going to have all your eggs in one basket in one bank. You do pay a fee, but you end up getting a higher yield, so yes, the industry is big. We're talking about serious bank flow here and the losses suffered in Money Market Funds… Actually, we're talking second decimals of losses in those funds.
We're not talking 'my gosh, the client's pension has been lost'. We're talking fractions of percentages for most of the fund investors.
ALEC HOGG: So it does carry a risk but on the other hand, you get a reasonable yield or a far better yield than you'll be getting for a deposit, perhaps directly, with the bank.
ANDREW CANTER: I think that's right.
ALEC HOGG: Andrew Canter is the Chief Investment Officer at Futuregrowth.