Institutional investors are demanding more transparency from their cash managers. Those who can deliver will get to keep their existing clients and maybe even snag a few from their competitors. Those who fail to give their clients a suitable level of comfort will potentially fall by the wayside as the likelihood that the industry will consolidate and be dominated by just 10 players intensifies.
These were among the key conclusions at the Institutional Cash Management seminar jointly organised by AsianInvestor and FinanceAsia.
"It takes a long time to build trust," says Robert Deutsch, US-based head of global liquidity at J.P. Morgan Asset Management. "When lost, it takes a long time to repair."
Deutsch recalls that during his last trip to Hong Kong in October, "it felt like the credit markets were collapsing around us". The market was preoccupied with talk of how the Reserve Fund -- the oldest money market fund in the US -- had announced that its Primary Fund had broken the buck with a net asset value of $0.97. That was the first time a 2a-7 regulated money market fund broke the buck since 1994, and for many investors that was unthinkable.
After all, a 2a-7 regulated money market fund was perceived to be virtually risk-free. Under the Investment Company Act of 1940 of the US Securities and Exchange Commission, rule 2a-7 restricts investments in money market funds by quality, maturity and diversity. Under this act, a money fund mainly buys the highest-rated debt, which matures in under 13 months. The portfolio must maintain a weighted average maturity of 90 days or less and must not invest more than 5% in any one issuer, except for government securities and repurchase agreements.
Fast forward to the present and investors now know that the perception of anything being virtually risk-free is completely wrong.
Clearly, the mismatch of risk and reward expectations has been going on for years, but as long as times were good, that didn't seem to be a problem.
"It's fair to say that there was an incredible amount of naiveté in the past two years," says David Russell, Hong Kong-based business head of securities and fund services for Asia-Pacific at Citi.
Nowadays, institutional investors are asking a lot of questions and are harder to satisfy.
"You have investors who are now starting to ask really granular questions about the custody of assets," says Citi's Russell, illustrating his point that many more investors want to have a full understanding of the workings of their cash. "Where are you holding the assets, who are the custodians, who are the sub-custody shops that are being used, do they provide an explicit guarantee? These sorts of questions are a lot more relevant now," Russell says.
Such questions reflect the current priorities of institutional investors: first, preservation of principal; second, liquidity; and third, investment yield. In the past, this set of priorities was traditionally in reverse order.
It takes size and scale to maintain strong relations with institutional clients, says J.P. Morgan Asset Management's Deutsch, who expects consolidation among large and well-resourced money managers. He notes that the top 10 managers of global institutional money market funds accounted for around 65% of total assets in July 2008, a figure that has risen to 73% and could jump to around 90% in the foreseeable future.
The fact that ratings agencies failed to see the warning signs of the impact of the credit crisis on specific products, for example, underscores the need for cash managers to make their own informed decisions, says Travis Spence, Hong Kong-based head of the global liquidity business for Asia-Pacific at J.P. Morgan Asset Management.
"That lends itself to managers who have greater resources," Spence says. "That will certainly prevail in the short-term."
Spence believes, however, that it is unlikely that the same risks that hurt the markets post Lehman Brothers would come back to bite cash managers and investors.
"The risks of something like this happening again are certainly less than they were in September. Plus, we have government programmes that can help prevent this from happening again. We do feel that Reserve Money was an isolated event," Spence says.
"We are getting back to basics where investors are really looking at the manager and the style and how the funds are being run in order to make an informed decision. The risks need to be managed and you have to have the right process to manage those risks. Everyone has woken up to the fact that risks are real and that triple-A doesn't mean that nothing bad will ever happen," he adds.
John "JJ" Neville, a Hong Kong-based executive director of institutional sales at Morgan Stanley, notes that investors in Asia have generally been more conservative than their Western counterparts, but now even more so. That's something else that can help shield them from a repeat of the credit bubble bursting, he says.
"If they don't understand it, they won't touch it," he says. "They will not invest in anything they don't understand."
For some investors, the need to understand a product goes to the extreme -- something that could well be the wave of the future.
"What we are seeing is a trend towards transparency. The idea that a service provider can provide you with a window directly to the holdings of funds is very attractive right now," says Citi's Russell, adding that this is already common in the US and starting in Asia.
Russell notes that Citi has a number of clients who are demanding that the "large chunk of assets" they put in a fund be handled through a platform where they can see every single trade on a daily basis.
"I think we are seeing some game-changing trends here in the way funds are being managed," Russell says.
Meanwhile, cash managers note that there are investors who prefer to put the bulk of their money in deposit guarantees. But even that, they say, cannot really be considered completely guaranteed.
They argue that these deposit guarantees are not proven. In Asia, they have only been put in place recently and have not yet been put to the test. It's one thing to get your money back. It's another thing to get your money back one year later.
Towards the end of his presentation, J.P. Morgan Asset Management's Deutsch talked about back to basics investing in cash and the valuable lessons investors must take in: increased yield comes with more risk; diversification provides a layer of protection; there is no "grey area" in cash; and clients need to have a thorough due diligence process with on-going assessments and annual reviews.
Having said all that, Deutsch capped his talk by surmising that "we will all forget these lessons in five years" -- which was really more of a challenge to industry players and investors NOT to forget.