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Fitch flags concentration risk in money market funds

Says Abil fallout not systemic.
Photo: Bloomberg

JOHANNESBURG – Fitch Ratings says the outlook for South African money market funds is stable but there’s scant potential for an upgrade in their credit ratings due to concentration risk.

“The credit quality [of South African money market funds] is very good, but relative to other funds globally, money market funds in South Africa are highly concentrated,” explains Alastair Sewell, senior director at Fitch Ratings.

Delinked from the sovereign credit rating, even the highest credit quality money market funds in South Africa have an AA+ investment grade rating, which is one notch below AAA – the highest investment grade. These are national scale ratings.

Sewell notes that this is because in South Africa, money market funds are allowed to have exposures of up to 30% to a single entity, increasing concentration risk. In Europe, maximum exposures to a single entity are limited to between 5% and 10%.

“In practical terms, the [South African] funds we rate are very concentrated, with up to 80% or 90% of their portfolio invested in the big five banks,” he says.

Rival ratings agency Standard & Poor’s (S&P) says it does not rate any money market funds in South Africa, primarily because it applies a global rating scale. “Our money market funds require a 5% per issuer limit, which means a more diversified investment portfolio although some concentration could occur for sovereigns’ securities (such as US Government), or overnight bank deposits (up to 10%),” says Andrew Paranthoiene, director of financial institution ratings at S&P in London.

“This ensures the highest credit quality, greatest liquidity and means investors are less likely to incur losses. We note that a number of Fitch-rated South African money market funds encountered issues in 2014 resulting in losses to investors.”

African Bank an idiosyncratic event

Paranthoiene is referring to the collapse of unsecured lender African Bank Investments Limited (Abil) in August 2014, which led to ten money market funds breaking the rand

Despite this, Sewell notes that Abil’s collapse did not result in industry-wide outflows. “There were some funds that suffered quite heavily, but there wasn’t a run on the industry as a whole,” he says, drawing a comparison with the Reserve Primary Fund in the US, which in September 2008 Bloomberg reported became the first money market fund in 14 years to break the buck.

“This led to very significant outflows industry wide in the US and the Federal Reserve provided a facility to support money market funds. It was a systemic event,” he explains.

“Here in South Africa, money flowed out of money market funds with exposure to African Bank and went into other money market funds rather than exiting the system entirely. It was idiosyncratic to African Bank and the industry-wide effect was relatively muted,” he explains.

Fitch downgraded the Absa Money Market Fund by three notches at the time and placed its credit rating, as well as that of five other South African funds, on a negative ratings watch. “The Absa fund was upgraded to AA+ when the ABIL exposure was removed as this materially improved the fund’s credit quality,” says Sewell.

All the other funds that were placed on a negative ratings watch were affirmed when Abil exposures were side-pocketed. The Investec Money Market Fund and the Investec Stefi Plus Fund, which chose not to side-pocket Abil exposures, remain on a negative ratings watch.

Last week, African Bank reported a R9.3 billion headline loss for the year to September 2014, flagging a R2.3 billion to R2.8 billion loss for the six months to March 31 2015.

Asset allocation in SA

Data from the Investment Company Institute (ICI) shows that South Africa’s money market fund allocation is similar to the rest of the world, but we have a much higher allocation to balanced, or multi-asset, funds.

Screen Shot 2015-06-12 at 12.23.46 PM

Source: ICI

According to the Association for Savings and Investment South Africa (ASISA), at the end of December 2014, the SA multi-asset sector held close to 50% of the assets under management in South African collective investment schemes (CIS) – more than double the 23% held five years ago.

This is reflected in the fact that, although assets in money market funds are stable, as a relative share of total CIS assets they have shrunk.

Screen Shot 2015-06-12 at 4.20.32 PM

Source: ASISA, Fitch

Sewell suggests that money market funds can be used more broadly in South Africa, as they are in the US where investors, including corporate treasurers, favour money market funds over bank deposits.

Screen Shot 2015-06-12 at 12.24.34 PM 

Source: Fitch, ICI

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