Credit crunch has an upside for money market funds

The global credit crunch seems like bad news all round, but it could have an upside for money market funds, according to STANLIB, the country's largest unit trust company.

The need for easier liquidity after the debacle in Americas sub-prime lending market has prompted the US Federal Reserve to cut its federal funds rate by 50 basis points to 4.75%.

The dramatic cut is seen by some as a signal that the rising interest rate trend of recent years is coming to an end, says Ansie van Rensburg, STANLIB's head of money market funds.

Expectations of a decline in rates are always good for money market funds as they pool various instruments into a structure with an average duration of 90 days. This locks in an advantageous return after a fall in interest rates while bank deposits instantly reflect the new level.

Van Rensburg adds: "The credit crunch also spotlights other positives for money market funds risk diversification and transparecy.

"Money market Funds are highly regulated. A fund is forbidden from committing more than 30% of its assets to a single counterparty. Assets have to be distributed across a range of highly rated banks.

"Internationally, there is great concern about opaque collateralised debt obligations. No one knows for sure which international banks are exposed to them and to what extent. This tends to highlight the advantages of using a much more transparent, risk-diversified and well-regulated instrument such as a money market fund."

STANLIB's money market specialist believes the growing expectation of a fall in rates in the coming year could well prompt a strategic reappraisal of tried and tested money market products.

Individual investors often use money market funds as a 'parking place' for cash and at the moment receive an effective rate 9.48% of from STANLIB's retail money market fund.

Optimum daily earnings versus bank deposits are key for institutions (with a 9.75% nominal rate currently on offer from STANLIB's Institutional Money Market Fund) and corporate investors (who get 9.90% from STANLIB's corporate money market fund). The rate on a bank deposit is 9.50%.

Van Rensburg notes: "Even when rates move higher, money market funds still deliver a competitive rate versus bank deposits. However, the prospect of an interest rate cut means the 90-day lag would increase their competitive edge still further.

"This potential for out-performance creates an added incentive to increase your money market exposure. It is a cyclical phenomenon, but the questions that will be asked following the turmoil in Americas sub-prime lending market could lead to a long-term review of the risk-and-return profiles of debt products, cash and near-cash.

"The money market is well positioned to benefit from a review like this."