Crane Data recently heard from a money fund industry veteran and former portfolio manager who has been reflecting on "Lessons Learned" from the money market turmoil over the past two years. We wanted to share these thoughts with other money fund professionals and investors, so we've reprinted some of the list below. The manager asked to remain anonymous.
The first lesson is, says the former PM, "There is risk, albeit limited risk, in money market funds. The possibility of stepping on a landmine cannot be completely eliminated with even the best processes, people, and depth of resources. Under the right set of circumstances, even US Treasury MMFs can 'break the buck.'" Next, he says, "Issuer default overrides all other risks (liquidity, pricing). The default of a single issuer assures 'breaking the buck' without external financial support."
He says also, "Frequent and quality internal communication is essential. Demand this communication and insist on total transparency. This includes communication between the portfolio management team and senior management, between portfolio management and credit research, between portfolio management and sales/client service, between portfolio management and fund administration, and between portfolio management and internal audit/legal/risk control." He adds, "Communicate with senior management to establish dollar maximum per issuer exposures in addition to percentage diversification limits. The 2a-7 guidelines establishing 5% per issuer maximum exposure is too high; 2.5% to 3.0% is a better maximum."
He suggests, "For prime portfolios, maintain at least 25% exposure to U.S. Treasuries to protect against adverse market conditions, characterized by falling prices and illiquid conditions for non-government obligations. Treasury holdings will experience stable/rising prices and good liquidity during a flight to quality scenario." The former PM continues, "Cultivate good working relationships and have a broad network established with direct issuers and broker/dealers. Understand that while these relationships are essential to managing portfolios, at the end of the day counterparties will act in their own best interest which is likely in the worst interest of the portfolio manager. Trust no one."
Finally, he says, "Shareholder incentives are at odds with portfolio management interests. The portfolio manager must expect shareholder deposit/withdrawal decisions and inquiries that make the achievement of protection of principal, provision of liquidity, and income generation more difficult." He adds, "The market is a cruel taskmaster. Only invest when satisfied with the answer to the question, 'What could go wrong and what is the likelihood of that occurring?'"
