By guest contributor, Elaine Li, Analyst, Atchison Consultants
Given the global low yield environment, there is a rising demand from investors for enhanced cash investments. To generate enhanced returns compared to cash funds, enhanced cash products (sometimes referred to as money market funds) tend to carry greater risks. Figure 1 below illustrates the risk/return characters among cash funds, enhanced cash funds and bond funds.
Figure 1: Risk and return spectrum across various types of funds
Source: Russell Investments
Similar to any cash funds, enhanced cash funds are exposed to credit risk, term risk and liquidity risk. These generally imply the risk of losing capital from the default by security issuers, the changes in interest rates that adversely affect the price of the securities and the inability to convert the securities into cash without any loss of capital. Given these risk factors, the returns for enhanced cash are sourced from each of the risk accordingly (i.e. credit premium, term premium and liquidity premium) and among all the premiums, credit premium is typically the main contributor of enhanced returns.
A number of enhanced cash funds suffered material losses of capital in the depths of the GFC, with some being forced to freeze and return capital to investors. 11 am accounts, banks bills, promissory notes, asset-backed securities and floating rate notes are all common constituents of enhanced cash strategies. Subsequent to the GFC, ASIC prepared a review of the sector showing enhanced cash on average held approximately 50% of their assets in traditional cash assets and 50% in higher risk fixed income securities, of which asset-backed securities being the most common. This second category of assets is sensitive to price movements, which under the stressed credit and liquidity conditions of the GFC saw enhanced cash fund unit prices materially impacted. This caught many investors unaware and caused a number of enhanced cash funds to receive material redemption requests from unitholders, and ultimately caused the freezing of at least ten of these during 2008/2009.
It is noted that enhanced cash products typically invest in high quality securities with an average credit rating of A+ or A1, where the probability of losing capital or suffering delayed payments is very limited. However as seen by the experience of the GFC, the search for additional return beyond cash rates must be done cautiously.