Trading off yield for liquidity: The new collective investment scheme regulations & money market funds...

"I used to think that if there was reincarnation, I wanted to come back as the president or the pope or as a .400 baseball hitter. But now I would like to come back as the bond market. You can intimidate everybody”

James Carville, former President Bill Clinton's political advisor, was spot-on; the bond market is truly powerful; investors hang onto every contour of the yield curve like a crystal ball on what tomorrow holds from a returns perspective. Keep this at the back of your mind, the point will begin to crystallise as we progress.  

There are about 24 regulated money market funds in Kenya. Money market funds are just one amongst a host of collective investment schemes used to aggregate capital and deploy in suitable vehicles for yield chasing investors. Other collective investment schemes include equity funds, bond/fixed income funds, balanced funds and special funds.

If you invest in money market funds, you need to consider what the Capital Markets Collective Investment Schemes Regulations of 2021 mean for your investment matrix. Here’s why. Part 8 of the regulations on Investment Powers introduces a new dynamic to the assets to which capital aggregated through money market funds can be deployed. Regarding money market funds, the regulation states and I quote

“Invests only in interest-earning money market instruments which have a maximum weighted average tenor of thirteen (13) months and includes credit rated or guaranteed commercial papers; Government securities, call deposits, certificate of deposit including fixed deposits in commercial banks and deposit taking institutions, and any other like instruments as specified by the Central Bank of Kenya from time to time” 

Effectively, with the prescription that money market funds invest in interest-earning money market instruments which have a maximum weighted average tenor of thirteen (13) months, the new regulations introduce caps on where within the yield curve money market funds can play as they straddle the trade-off between liquidity and yield. Going forward, it is likely that we will see money market funds report more modest returns than the high single digits they have been delivering lately since their playbook has constraints when it comes to the extent to which it can extend to the long-term end of the yield curve. 

This is not to say that the new regulations are a cause for concern. Not at all. If anything, I believe they are a step in the right direction.

First, the recent past has offered very painful, but good lessons, as to what asset-liability mismatch could mean for a fund (and investors) especially in the event of a shock. In the words of Myron Samuel Scholes “at times of shock, converting illiquid assets to cash to build flexibility is very expensive. Finding an umbrella in a rain storm might be impossible or very costly”. Second, I believe the capital markets are a continuum in which money market funds are designed to facilitate recycling of liquidity as the core objective and the hunt for yield as a secondary priority. In short, one's money market fund should be the closest thing they have to cash in the bank, accessible within a relatively short time.

That said, it will be interesting to see what returns money market funds will offer going forward as they adjust to the provisions of the new regulations. No doubt, a number were already operating within this framework and won’t be adjusting. For those that now have to reset their portfolios, we wait to see what the return profile will look like.