Money markets is one of only three Sectors to see double digit returns over three years to the end of february, with a mean return of 13.69%
The money markets sector has been a safe haven for investors over three years to the end of February, one of only three IMA sectors to see double-digit returns over the period.
The 13.69% mean return for the sector compares well with equity markets and managed funds over the same timeframe. The conservative asset class shows little variability between funds, with three-year returns ranging between 11.17% and 16.8%.
Kate Jones, manager of the Fixed Income portfolio at M&G, puts this relative uniformity down to the nature of the funds which, in essence, invest in debt linked to central bank interest rates.
She said: 'We are all looking to offer solid performance to investors and give a cash-type return with a little added on top.'
This proposition has become increasingly attractive to investors who have suffered from high equity market volatility and seemingly non-stop negative returns in recent years, she added.
Paul Gibbs, head of treasury at Threadneedle, also sees market conditions boosting the popularity of money market funds and believes it is possible there will be an exodus of funds from the sector when equity markets pick up. 'People may have been parking their money in these funds as they saw equities falling,' he said. 'Returns from this sector are not exciting and people may start to move money out when there is more confidence in the market.'
Recent investor outlook has helped Jones's fund increase in size from around £10m three years ago to more than £50m today. She said this liquidity has made it easier for her to quickly take up positions in options she believes are attractive.
The Threadneedle UK Money fund has also seen a big increase in size over its three-year lifetime, with assets under management increasing to £240m from £114m at the start of March 2000.
Jones's M&G fund has seen the third best performance in the sector, with a return of 15.55% against the sector average of 13.69%. Performance has been steady throughout the three-year period, with the fund returning 0.6-0.7 percentage points above the average in each of the three years. Jones believes this is due to good decision-making in the floating rate note market.
The fund also benefited from a shift towards asset-backed bonds, she said.
The portfolio is currently more than 50% comprised of this type of debt compared to around 20% three years ago. While this area has continued to drive performance, the type of bond the fund purchased has changed a lot over the past year.
Jones said: 'We have recognised the overheating in the residential property market so have shifted away from buying debt backed by newer mortgages. We are still buying mortgage-backed debt but we are focusing on older books of business for which the risks are lower.'
She added that while the housing market has been heating up, the situation is not comparable to the 1980s when the property market crashed.
She said low interest rates mean house prices would be unlikely to fall sharply and the relatively stable economic background means that large scale defaults are not very likely in the near future.
Jones feels buying securitised debt makes sense from all perspectives. She said: 'If you buy Telereal, which is BT's rent-backed debt, you are getting better returns and higher-rated debt. This is largely because it is a more complex area that many parts of the market do not fully understand.'
The strong research facility at M&G has helped the fund pick debt that houses with smaller teams may not be able to locate, she added.
Jones said she countered the higher risk of default by increasing the diversification of the fund. It currently has around 80 holdings compared with 40 three years ago.
The fund does go down the yield curve as far as BBB-rated short-dated notes but has never suffered a default, Jones noted.
The low-risk nature of the money markets sector means all its component funds have a low beta, although at 0.7, the M&G portfolio is slightly higher than the 0.66 sector average. This is because the fund does not invest directly in deposit accounts like some in the sector, Jones said.
Gibbs' Threadneedle fund is slightly more conservative, not going below A-rated paper on short-dated corporate bonds. The fund is also more diversified than the M&G fund, with 83 floating rate notes and 36 other holdings.
The floating paper includes credit card debt, consumer loan debt and mortgage-backed debt but no collateralised debt obligation paper. Non-floating paper includes roughly a quarter in fixed rate bonds and a quarter in paper issued by banks, with the rest being made up of asset-backed commercial paper.
The Threadneedle vehicle also has a relatively high beta, at 0.78, again due to the low proportion of money being held in deposit accounts. The fund with the lowest beta in the sector is Aberdeen's Cash Income, with a figure of just 0.11%.
This low volatility did not seem to help the fund as it returned 12.56%, the third lowest return of the 35 funds that posted three-year returns. The highest beta was for Baring Cash fund at 1.08. This relatively high volatility was compensated by strong performance, returning 15.96% across the three-year period. The fund returned the second highest of all the single year returns at 6.15% for the year to the end of 2001 against the sector average of 5.52%.
The relative lack of individuality among funds in the sector is highlighted by the average R-squared, which shows deviation from the sector being just 0.24%. The Threadneedle UK Money Securities fund also avoids deposit accounts, holding only a small amount in overnight deposits for liquidity purposes.
The fund was the fourth best performer over three years, with a return of 15.7% against the sector average of 13.69%.
It was also the fourth best performer for the year to the end of February 2003, with a return of 3.89% against the sector average of 2.95%.
For the year to the end of February 2002, the fund was the second best performer, with a return of 4.96% against the average 4.32%. It also posted a top four return for the year to the end of February 2001, with 6.11% against a sector average of 5.52% Over five years, Gibbs said the fund's performance is even stronger.
Like the M&G fund, much of the outperformance of the Threadneedle vehicle has been driven by floating rate notes, according to Gibbs. The fund has had a fairly consistent 50% holding in these investments, he said.
Threadneedle UK Money Securities generally holds debt with maturity dates of 40-120 days, although it has held debt with longer maturity dates for most of the past three years as Gibbs has seen little sign of any increase in interest rates.
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