Liquidity funds

Money Market Funds (MMFs), often referred to as Liquidity Funds, are pooled investment vehicles with a dual objective of capital stability and liquidity. MMFs adhere to liquidity, interest rate, and credit risk constraints which are typically defined by regulation, fund rating agencies, as well as the asset manager. MMFs invest directly into the money markets (through deposits, reverse repurchase agreements (repo), money market instruments, and short-dated bonds), providing potential for returns to be higher than alternative cash investments (for example, cash on deposit or with a custodian/investor platform).

Some MMFs are permitted to transact at a constant price and offer same day settlement, leading to them being considered as a cash management utility as well as an investment product. There are four types of MMFs available to global institutional investors: the Public Debt Constant NAV (PDCNAV), the Low Volatility Net Asset Value (LVNAV), and the Short Term and Standard VNAV Funds (VNAV).

Liquidity management is the efficient management of assets to meet payment obligations (i.e. managing funding, liquidity, and market risk).

Money Market (or Liquidity) Funds invest selectively in a range of money market and fixed income assets including deposits, repurchase agreements, certificates of deposit, commercial paper and short-dated fixed or floating rate bonds.

For cash allocations where daily capital stability and same day liquidity is not required, ultra-short duration or liquidity plus strategies provide the potential for an increased return, commensurate with an extended investment horizon (for example, 6 – 12 months).

While the parameters short-term money market funds operate within are well established and understood, there can be significant differences between ultra-short duration or liquidity plus strategies. There are four key considerations for cash investors when evaluating these strategies:

The investment horizon, and how a portfolio is designed to target capital stability within that context.
 

The fund rating. While a bond fund rating assigned to a liquidity plus fund is less prescriptive than a short-term money market fund rating, they can provide a guide to overall credit quality and sensitivity to market risk. A bond fund rating will typically consist of a credit and market sensitivity component.
 

How return is targeted. A short-term money market fund seeks to generate return through a controlled combination of duration and credit risk. An ultra-short duration or liquidity plus fund has more flexibility, so investors need to be comfortable with how risk is allocated and managed.
 

The investment capability of the provider, including its credit research resource, and where the fund fits within a range of investment products offered.

Fund ratings provide an independent opinion of portfolio characteristics and the providers capability and experience in managing the type of fund.

A money market fund (MMF) rating reflects the agency’s opinion of a fund’s ability to meet the objective of capital stability and liquidity. It is derived from an assessment of the asset manager’s capability and portfolio characteristics, as well as ongoing surveillance.

Standard & Poor’s, Moody’s, and Fitch produce MMF ratings, which can be identified by an ‘m’, ‘mf’, or ‘mmf’ suffix.

While bond funds do not have a capital stability and liquidity objective, a bond fund rating can provide an opinion of credit quality, sensitivity to market risk, and manager capability. A bond fund rating typically includes a credit risk component, reflecting a forward-looking, maturity adjusted, assessment of the overall credit quality of the fund, and sometimes a score to reflect sensitivity to market risk.

Standard & Poor’s, Moody’s, and Fitch Ratings provide bond fund ratings, which can be identified by an ‘f’ or ‘bf’ suffix.

Fund tokenisation refers to the creation of digital tokens, recorded on a blockchain, that represent ownership in an investment fund.

A token is a digital representation of share ownership using Distributed Ledger Technology (DLT). Tokenisation may be implemented directly on the fund register, or through a third party that records ownership on a sub-ledger without affecting the underlying fund register.

Money market funds have been among the earliest adopters of tokenisation, reflecting their important role for cash management within the financial system.

While still in the early stages of adoption, many asset managers now offer tokenised MMFs, either through external providers or directly within their fund infrastructure.

Growing interest in tokenisation reflects the potential benefits, which include:

Increased efficiency. DLT provides a single source of truth, reducing duplication, reconciliation requirements and operational friction across the investment value chain.
 

Additional utility for investors. Digital asset transfer may allow investors to remain invested for longer while retaining greater flexibility over ownership transfer.
 

Improved liquidity and faster settlement. Direct transfers between approved participants may support liquidity outside traditional fund cut-off times and enable faster settlement.