In the 1987 movie Wall Street, Michael Douglas as Gordon Gekko, while giving an insightful speech to a packed audience, said: "Greed, for lack of a better word, is good." He went on to say: “Greed, in all of its forms; greed for life, for money, for love, knowledge has marked the upward surge of mankind.”
However, it is also noticeable that he failed to highlight the ugly side of greed, ostensibly because he was defending himself against charges of greed. But nonetheless, his character offered us an entertaining sneak preview of everyday greed. The financial marketplace continues to be the epitome of greed.
A case in point is money markets, whose participants have an infinite penchant (or greed) for yields. In fact, industry players have christened it as a ‘yield market’. A couple of weeks back I tweeted about the mismatch between money market funds returns and the risk-free rates (specifically the 91-day Treasury bill), a tweet that generated a lot of interactions.
At the time of this writing, the latter was sold at just under seven percent, while some money market funds were crediting at rates above 10 percent.
What’s a money market fund anyway? It’s a collective investment product that pools money from a wide investor base, mostly retail, and invests in low-risk, liquid interest-bearing assets.
The whole premise of a money market fund is short-term capital warehousing in a low-risk but highly liquid platform while preserving capital. In terms of allocation, we are talking government securities, short-term corporate commercial papers, fixed or call deposit placements with commercial banks and even equities for the more aggressive funds.
This often presents an allocation puzzle: since risk is directly proportional to returns, how does the asset allocator balance returns versus risk? Obviously, if you want to deliver alpha, then you must accumulate risks.
However, as an investor eyeing a money market fund, your investment consideration shouldn’t just start and end with returns (or yields).
Rather, you should also be concerned with the underlying risks that the fund is exposed to.
This is why, in my view, something like money market fund risk ratings becomes important as an additional investment criterion (and is something that the market should now embrace).
Fund ratings, unlike the normal institutional credit rating, can give an investor an independent assessment(s) of a fund’s asset allocation against a number of risks—namely currency (in the case of foreign currency exposures), liquidity, credit, interest rate and price.
For instance, a money market fund can be delivering double-digit returns, but at the expense of exposure to a corporate commercial paper whose issuer has high default risks; in which case, it is exposed to significant credit risks.
A fund can also be exposed to an asset in, for argument purposes, Zambia, which comes with exposure to currency risks. In both cases, the risk of capital loss is high.
Conversely, a fund can be yielding modestly above risk-free rates (for instance 7.5 percent), but on the other hand, it is exposed to highly liquid and defensive assets with little (or no) risk of capital loss.
Consequently, in terms of risk ratings, asset allocations with high risk of capital loss (but high returns) is likely to score poorly compared to an allocation with low-risk of capital loss, but low returns.
Additionally, because of persistent high levels of opacity in the marketplace, a fund risk rating can also help an investor get an idea of the nature of asset allocation.
In summary, investors, especially retail, should stop this fixation (or greed) with yields and start parsing asset allocation risks.
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Note: The results are not exact but very close to the actual.
