Money market funds are able to deliver positive returns year on year but struggle to differentiate f...
Money market funds are able to deliver positive returns year on year but struggle to differentiate from their peers in performance terms.
Outperformance relative to the peer group is particularly difficult to find as the number of investment strategies open to cash fund managers is limited by stringent regulations.
While money market funds are more immediately affected by changes in interest rates than equity funds, diversity in performance is always going to be less because of the very nature of the underlying assets' volatility.
Over three years to end of May 2001, the average money market fund returned 17.39% and the difference in returns between the best and worst performing funds in the sector was just 3.8%.
Subsequently variation either above or below the mean has been low, with performance swinging between 1.88% above the sector average and 1.92% below.
Fidelity Cash, managed by Andrew Wells, has returned 16.85% over the three years to end of May this year, underperforming its peer group average by 0.54% over the same period.
Wells said this marginal underperformance could be attributed to a number of factors. One of the main reasons being the very success of the fund.
'Because we have one of the largest funds and have a lot of money flowing in and out of the portfolio, we have got to keep a lot of money at the short end of the market to keep the liquidity within the fund's parameters and meet customer redemptions,' he said.
Smaller funds that see less inflow and outflow activity are able to invest in longer dated securities, up to the FSA's limitations, Wells added.
Given that the sterling base rate is 5.25%, the one year lending rate 5.42% and the overnight lending rate 4.3%, an ability to invest at the longer end of the market can provide those extra few basis points that are enough to give outperformance in the money market classification, he said.
In order to deliver the strong performance that Fidelity Cash has nonetheless achieved, Wells and his team of analysts focus on a number of variables affecting the money market.
'First, we have to make sure we know in which direction interest rates are going and position the fund for that. Because interest rates are going down, we make sure the fund is positioned as long as it can be,' he said.
'The credit analysts basically look at the investments we make and at the ability of the underlying institutions to return that rate of interest in a timely fashion.'
Wells said he generally looks at banks other than the large clearing houses, which have equally strong credit ratings but lack the easy access to sterling that the clearing banks enjoy and therefore generally have to pay more for it.
He added a number of banks also raise capital in foreign currency against sterling, which can lead to returns over the base rate.
'Lots of banks are looking to raise assets in different currencies. When banks place assets in sterling to raise cash in say, dollars, there are pricing opportunities,' Wells noted.
While Fidelity Cash has a slightly below average beta of 0.9%, compared to a sector average of 0.91%, Wells said investors should not read too much into these figures.
He points out that the sector is diverse and funds are subject to different regulatory constraints and not all funds are actively managed.
'You are not comparing like with like. Liquidity and diversity is what you should look at,' Wells said.
Indeed, a number of fund management groups do not actively manage or market their cash funds and they are often only provided as a by-product of restructuring or to complete the fund range. Martin Currie Cash was the worst performing fund in the sector over the three years to end May this year, returning 15.47%.
Ross Leckie, communications director at Martin Currie, said the fund, which contains around £300,000, came about after the restructuring of an investment trust and was not an actively managed or marketed vehicle.
Aegon Cash is similarly dormant. Again not actively managed or marketed, the fund has still managed to outperform the sector average over the three years to the end of May 2001 by 0.18%, returning 17.57%. As a consequence of the decision not to actively manage the fund, its beta has risen to 2.26% compared to a sector average of 0.91%, but it has outperformed on an annualised basis over the past three years.
Henderson Cash has also outperformed over the three years to the end of May 2001, returning 18.38%, some 0.99% above the sector average.
The fund, managed by Brian Turner, follows a conservative management strategy.
'We always try and keep this fund safe and simple. We have always viewed it as an important vehicle to have when markets are uncertain,' Turner said.
The fund aims to outperform building societies rates, Turner said, but places strong emphasis upon maintaining a high level of liquidity, given the transient nature of much of the money invested in it.
'We are quite conservative on the different institutions we lend to and lending to the better rated institutions means we will rarely outperform the mean,' he noted.
The fund does not invest in instruments dated over one month and closely monitors the short-term interest rate outlook to choose the right period to invest and get the maximum returns upon that investment, Turner explained.
'We deal with 50-60 banks each day and speak to five or six brokers to find out who is paying what,' he adds.
While admitting that cash funds are not the most sought after investment vehicle, Turner said that by not running such a fund, fund managers risk investors pulling their money out of the market completely when equity sentiment is negative.
By enabling investors to rest their money in a cash fund, this money stays with the company, gaining interest for the client until they are ready to re-invest in an equity fund.
Regression analysis: Regression statistics can be used to compare the relationships between funds, markets or a specific benchmark index. They do not make the assumption that the variables (funds) are related as cause and effect, but permit them to be influenced by other variables (markets).
Alpha: The Alpha describes the theoretical reward obtained by one investment when the second investment has a zero return. To calculate the Alpha, the returns of each are taken and compared together to identify their relationship. This reveals relationships between investments in both bull and bear markets. When applied to portfolios, it can be considered to be the return over and above (or below) the market through portfolio strategy. Good managers have a positive Alpha.
Beta: The Beta is the amount the first fund moves when the other moves by one unit. Beta is a measure of relative volatility (absolute volatility is calculated by standard deviation).
If one fund always goes up and down by 1.5 times of the performance of the index, its Beta will be 1.5. This implies that if the return of the index is positive, then 1.5 times this positive return can be expected of the fund. If the index goes up (or down) 10%, the fund goes up (or down) 15%. Beta represents the volatility of the first investment versus the second. It is only an estimate and to be accurate there has to be a perfect correlation between the two investments.
Correlation: Correlation shows the strength of a linear relationship between two funds. A perfect correlation is when the investments behave in exactly the same manner. A perfect positive correlation is represented by 1, perfect negative correlation by -1 and no correlation with a 0. A perfect negative correlation suggests that for every 1% movement by the index we would expect to see -1% movement return on the fund and vice versa. This is an important factor when using modern portfolio theory.
R-squared: The R-squared indicates the level of movement that can be ascribed or determined by the movement of an index. When the R-squared equals 1 there is a perfect correlation between the investments ' 100% of the movement in a fund can be determined by the movement in the index. When the R-squared equals 0, there is no correlation between the investments. An R-squared between 0.7 and 0.99 suggests that between 70% to 99% of the movement in our fund could be explained by the movement in the index. Below 0.3, there is effectively no influence.
Monthly volatility (or standard deviation): Standard deviation is a measure of absolute volatility. It is the measure of the square root of the variance of each monthly return from the mean. The larger the figure, the higher the volatility of a fund and thus its risk. A typical example of the kind of funds and their associated risk ranging from low risk to high risk are: cash funds, fixed interest funds, balanced funds, UK equity funds, overseas equity funds and warrant funds.
Source: Standard & Poor's
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