Money market fund cap set to raise credit risk

Money market fund managers could be forced to inject increased risk into the products under Investment Management Association (IMA) plans to adopt a European definition for the sector.

The IMA is thought to be gearing up to use a short-term definition for the funds—capping their weighted average maturity at 60 days—which has been issued by the committee of European securities regulators rather than the alternative long-term definition, which has no maturity cap.

The cap would mean that the funds are forced to take on more credit risk to outperform cash. Currently, they can try to perform via trading interest rate risk as they are allowed to run weighted maturity averages of up to a year.

Funds in the £12.5 billion IMA money market sector aim to protect investors’ capital while beating cash returns. (article continues below)

Paul Smith, Premier’s £106m UK money market fund manager, says he believes the IMA is likely to use the short-term definition but is urging them to reconsider.

He says: “Money market investors would be dismayed to learn that managers might no longer be interested in the future direction of interest rates.

“The best-performing money market funds during the credit crisis may have to change their investment approach following the changes, yet some of the volatile funds which lost inves-tors money will still be able to continue just as they were during the depths of the crisis.”

But Tim Foster, Fidelity’s £290m cash fund manager, says: “Our funds have always been run with a maximum weighted average maturity of 60 days. Any new peer group will still be likely to contain funds with higher risk profiles than our funds and it will become even more important for investors to pay close attention to the investment process and risk management practices of the fund manager they choose.”

An IMA statement says: “The IMA awaits the FSA’s implementation of CESR’s guidelines which will be reviewed in early 2011.”