Tighter controls on the instruments in which money market unit trust funds can invest, which were introduced this month, may have an impact on the yields you earn in these funds.
Fund managers’ views on the changes differ, with one saying they could reduce yields by as much as half a percentage point, and others saying their yields could improve.
Most agree the changes clarify what is allowed and will level the playing fields for all fund managers.
The Association for Savings & Investment SA (Asisa) says the changes are likely to have only a slight impact on money market fund yields, much less than the impact of the latest interest rate cut.
Limits on the securities in which unit trusts can invest have been set by the Financial Services Board in a notice issued under the Collective Investment Schemes Control Act.
Until the end of last month, a notice issued in 2005 (notice 1503) applied, but this notice has been revised and reissued (as notice 80 of 2012) with new limits on the securities in which funds can invest, coming into effect on July 1.
Under the old notice, money market funds were limited to investing in instruments which together gave the fund a weighted average maturity of 90 days.
The weighted average maturity of instruments is the average length of time to maturity of the instruments, weighted to reflect the holdings in each instrument.
However, some funds investing in floating-rate notes (instruments with interest rates that are reset during the life of the note), used the period until the interest rate was reset as the period to maturity.
Peter Blohm, Asisa’s senior policy adviser, says these instruments typically have a duration to legal maturity that exceeds a year – for example, two years – but they reset their interest rates every 90 days.
When the 2005 notice was drawn up, floating-interest-rate instruments were only starting to be issued, he says.
To protect you as an investor, regulators want to ensure that money market funds can sell all the instruments in which they invest at relatively short notice and without penalty, Blohm says.
As a result, the revised notice limits money market funds not only to investing in instruments with a weighted average duration of 90 days but also with a weighted average legal maturity of 120 days.
The average legal maturity of the instruments in a fund refers to the average length of time remaining until the principal value of the instruments will be repaid in full, the new notice says.
The requirement that funds consider the weighted average legal maturity of their funds is in line with requirements set for collective investment schemes by other countries’ regulators, Blohm says.
He says Asisa has not assessed the impact the new limit will have on money market fund yields, but believes the effect will be slight.
Some managers were interpreting the rules differently and there may now be a narrowing of the gap between the yields funds are delivering, he says.
Eldria Fraser, the chief investment officer of Prescient Investment Management, says money market funds will be forced to hold shorter-dated instruments as a result of the changes and this could affect yields negatively by up to an estimated half a percentage point.
But Ansie van Rensburg, the head of Stanlib’s money market franchise, says Stanlib expects to be able to lengthen the legal maturity dates of its portfolio and therefore deliver a higher yield.
She says there is now no confusion on how to determine the limits.
Sandy McGregor, Allan Gray's money market fund manager, says Allan Gray has been applying rates very similar to those in notice 80 and expects to be able to continue to deliver “superior returns”.
Lisa MacLeod, portfolio manager at Investec Asset Management, says the impact is likely to be minimal because from July 1 to date Investec has not seen any impact on market yields and spreads.
Ameesha Chagan, portfolio manager at Futuregrowth, says there could be a fall in yields in certain money market portfolios where managers were investing in longer-dated, higher-yielding instruments.
Pieter Koekemoer, head of the retail at Coronation, says all money market funds are likely to be slightly negatively affected, but the effect will be much smaller than the impact of this week’s rate cut.
Other regulation changes for collective investment schemes
Revised investment limits for unit trust funds omit any references to the credit ratings of investment instruments.
Under the old investment limits set in a notice under the Collective Investment Schemes Control Act (Cisca), notice 1503 of 2005, money market funds were limited to investing certain amounts in credit instruments in accordance with the credit ratings that ratings agencies assigned to these instruments.
The revised investment limits (in notice 80 under Cisca) make no reference to credit ratings.
Managers will be expected to conduct their own due diligence on unlisted instruments in which they invest and to satisfy the trustees of their funds that they have a risk management programme to identify and measure, on a daily basis, the risks of the investment.
They can still make use of credit ratings if they wish to do so.
The reputation of credit rating agencies was tarnished after the sub-prime crisis when it became apparent that many high-risk loans had been bundled together and packaged as securitised investments. Agencies gave them a lower risk rating than was justified.
In 2009, a money market fund used to provide bridging finance to property developers, the Cash Managed Fund managed by Corporate Money Managers, closed, leaving investors with heavy losses. The instruments in which the Cash Managed Fund was invested were rated by ratings agency Global Credit Ratings, but when the ratings of the instruments changed, the change was not widely reported.
Instead of limits set in terms of instruments’ credit ratings, all collective investment schemes now have to abide by new limits that apply to non-equity securities.
For example, a fund cannot invest more than 30 percent of its assets in a bank with a market capitalisation of more than R20 billion and no more than 20 percent of its assets in a bank with a market capitalisation of between R2 billion and R20 billion, Peter Blohm, senior policy adviser for the Association for Savings & Investment SA, says.
The revised investment limits notice under Cisca has also changed the requirements that collective investment schemes must meet when investing in unlisted securities, including corporate bonds issued by unlisted entities.
Under the old notice, funds could invest 10 percent of their assets in unlisted securities, but these securities had to list within 12 months, Blohm says.
As of July 1, under the revised notice, funds can invest 10 percent in unlisted securities but there is no requirement that they list.
Any unlisted securities must be valued on a daily basis.
Blohm says this will allow funds to include unlisted derivatives in their portfolios of up to 10 percent of the fund. However, only five percent of the fund can be invested in a single unlisted entity.
The investment limits for corporate bonds will be the same as for equity securities, and all unit trust funds will be limited to investing no more than 10 percent of the fund in equities or bonds issued by a single listed entity and five percent in the equities or bonds of an unlisted entity.
Blohm says the impact of these changes for funds that invest in corporate bonds is likely to be minimal because the issuances of local corporate bonds have been limited.
New limits have also been introduced for funds that invest in securities as well as other funds.
Previously, collective investment schemes were limited to investing 20 percent of their assets in other collective investment schemes. This limit has been increased to 80 percent, but only 20 percent of the fund can be invested in a single fund.
The underlying funds must also not invest more than 20 percent of their assets in another collective investment scheme.
Blohm says the aim of this limit is to prevent investors paying cascading costs because funds at each level levy asset management charges.
Funds of funds, which invest exclusively in other funds, will still be limited to investing in at least two funds, with no more than 75 percent of the fund in a single underlying fund.
Blohm says these changes bring the regulation of local collective investment schemes more in line with the Undertakings for Collective Investment in Transferable Securities (Ucits) requirements that apply to funds in the European Union.
Money market funds not immune to failure
The liquidity risks a money market fund can face were highlighted in 2009 when a local fund that mimicked a money market fund, the Cash Managed Fund, managed by Corporate Money Managers, closed, leaving investors with losses running into hundreds of millions of rands because the fund’s underlying investments could not be liquidated.
The fund invested in notes issued to provide bridging finance for property developments. The notes had a term of six months, but the notes never matured because the issuer was unable to liquidate them.
It has been reported that the curators of Corporate Money Managers and the Altron Pension Fund recently served summons on Absa Bank and Absa Bank Nominees for failing as custodian of the Cash Managed Fund to ensure that the fund invested in liquid instruments. The reports say investors’ losses amounted to about R850 million and the fund lost R48 million.