IMMFs Prove their Worth

The institutional money market funds industry in Europe has grown at a phenomenal rate over the past ten years with funds under management of less than $1bn in 1995 increasing to $255bn in June 2005.

Seen primarily as an alternative to bank deposits, investors with excess liquidity have used such funds due to their low credit risk and ability to achieve competitive returns when compared with bank deposits.

INSTITUTIONAL MONEY MARKET FUNDS

Institutional money market funds (IMMFs) are mutual funds that invest in high-quality short-term debt instruments. Typically these instruments will include certificates of deposit, commercial paper, floating rate notes, repurchase agreements, short-term government securities and time deposits.

Managers apply strict credit criteria to their selection of such instruments and all funds of this type managed by members of the Institutional Money Market Funds Association (IMMFA) are rated as triple-A by one or more of the credit rating agencies.

Institutional money market funds offer daily liquidity and are used by institutional and corporate investors amongst others for daily cash management purposes. Most IMMFs offer readily diversified portfolios, particularly those registered in the EU as compliant with the UCITS Directive.

UCITS funds must operate within the Directive's diversification requirements. These limit exposure to a single issuer to a maximum of 10% of a fund's assets (for 40% of the fund), with the remaining 60% having a maximum exposure of 5% per issuer.

Such rules ensure that the manager provides readily diversified portfolios of holdings to investors. As part of the rating process, rating agencies regularly review the diversification of fund portfolios and will raise concerns with investment advisers should there be doubt about the level of diversification within a fund.

IMMF OBJECTIVES

The primary objective of IMMFs is preservation of capital, with secondary objectives of liquidity and competitive returns. The funds managed by IMMFA members are triple-A rated and quality assurance is to a large extent provided through regular scrutiny by rating agencies to ensure continued compliance with the rating criteria.

The rating criteria take account of a fund's asset range and restrictions (such as credit quality, type and currency), acceptable counterparty risk and acceptable choice of custodian.

IMMFA members (and their funds) also abide by the association's code of practice, which aims to ensure that members offer a consistently high-quality product and service to investors.

Institutional money market funds have been popular in the US for many years and IMMFA was set up in 2000 in order to promote similar funds across Europe.

Mainly domiciled in Ireland, Luxembourg or the Channel Islands but generally managed in London, the range of triple-A rated IMMFs on the market do not vary widely, but small differences do exist: all funds will provide daily liquidity, but cut off times vary as do the minimum investment amounts.

There are also differences of performance between funds and differences in fees. Generally IMMFs levy an annual management fee but do not apply an initial charge. Ultimately, choosing a fund and a provider depends largely on your investment objectives.

The five-fold growth in popularity of IMMFs over the last five years reflects an increase in use by corporates, local authorities and financial firms. This growth is expected to continue for the foreseeable future as the benefits in support of 'outsourced' liquidity cash management becomes more understood by corporate treasurers and the changing regulatory environment makes it competitive for banks to also use such funds.

IMMF ADVANTAGES

There are several key advantages for investors using money market funds when compared with traditional bank deposits:

• Many banks have lower credit ratings than triple-A money market funds
• Money market funds provide an easy gateway to diversification
• For large amounts of surplus cash, counterparty limits with banks may be insufficient while institutional money market funds require no such restriction

All in all, interest by treasury professionals in using triple-A rated institutional money market funds to support their liquidity requirements is on the increase in Europe.