Enhanced cash managers say the failure of some funds that invested in relatively risky structured credit products has unjustifiably tainted the market segment.
"The negativity came out of misinformation from the media and a lack of education on the part of investors," says Bruce Bent, vice-chairman and president of New York-based investment company The Reserve, which runs an enhanced cash portfolio.
Alarm bells ring
In August, US cash management company Sentinel Management Group froze client withdrawals, stating that it could not meet redemptions without selling securities at deep discounts to their fair value. It subsequently filed for Chapter 11 bankruptcy protection. This set alarm bells ringing for money market and enhanced cash investors. However, Bent says Sentinel was very different from an enhanced cash fund. "It was basically a fund-registered investment pool. They were not investing in the philosophy of a ‘2a-7’-type strategy," he says.
US money market mutual funds are governed by SEC rule 2a-7, which permits them to invest only in low-credit-risk securities, such as short-term government debt, certificates of deposit and commercial paper of companies. The underlying securities must have a maturity of less than 13 months and the funds have to maintain a constant net asset value of one dollar per share, which means that for every dollar an investor puts in, they get a single share of the fund in return. Enhanced cash funds, which can also be called enhanced yield, cash plus or Libor plus funds, do not have to comply with rule 2a-7 but should still be relatively conservative in their strategies. They aim to outperform money market funds on a total return basis by taking on a little more interest rate, credit and liquidity risk. They generally invest in slightly longer-dated securities than money market mutual funds. Typically, this can include fixed-rate and floating-rate agency debt and corporate bonds, but could also include asset-backed securities.
Bent says the implication was that Sentinel offered close to money market-type risk and return when in fact it was not as conservative as an enhanced cash manager. The result was that some institutions pulled their money out of enhanced cash over the summer. But he says investor confidence has now returned, and that the repricing of risk bodes well for the sector. "For a long time enhanced cash products were not that different from money funds [in terms of yields] because you weren’t getting paid for the risk. Now the market has been getting much more back to normal," he says.