Investors are increasingly looking to money market funds to provide some stability in uncertain times. Steve Matthews, manager of the LF Canlife Sterling Liquidity Fund discusses the importance of liquidity and quality, and the challenges of providing an attractive yield.
After last April’s Covid-inspired liquidity crisis, SONIA resembled a 50-year flat line rather than a curve. No longer. A Brexit deal, immunisation and better GDP numbers have created a more bullish view on interest rates. But with the upward kinking of the curve come new considerations.
Will the curve retain its current shape over the coming months? Or is inflationary pressure going to force the Bank of England’s hand, causing a more rapid increase in the Bank of England’s base rate?
Rising unemployment could provide a strong deflationary impetus. On the other hand, pent-up demand and structural supply shortages suggest rising inflation. We are unlikely to see how this plays out until after September, but it is difficult to ignore mounting inflationary pressure and potential for tapering of quantitative easing or rate rises.
Liquidity vs yield
There is always a trade-off between yield and liquidity. In our investment approach liquidity over-rides any curve considerations, so our primary focus is to ensure that we maintain our elevated overnight and one-week maturities.
To strike a balance between yield and liquidity, we also hold some high-quality fixed and floating rate bonds that provide suitable yields on a risk/reward basis, along with a high degree of liquidity thanks to the transparent two-way pricing of these assets. This is not a feature of short-dated commercial paper and certificates of deposit markets – although these, too, play an important role in adding diversification and yield and augmenting the maturity ladder.
When looking to add yield, it is still appropriate in the current environment to add some fixed income assets if their value will shine through until maturity, together with covered floating rate notes that can enhance returns and give a useful hedge against rates rising. However, with little value currently on offer in between, we have adopted a bar-bell approach to investments that favours SSA (sovereign, supranational and agency bonds) and covered over senior unsecured bank assets.
An alternative home for cash
We launched the LF Canlife Sterling Liquidity Fund to create an alternative to the larger cash funds available to institutional and discretionary investors. First and foremost, we wanted to provide security, liquidity and stability. We also wanted to deliver an attractive yield, but without compromising our commitment to liquidity and risk management.
Originally set up with £140m of Canada Life International unit-linked cash fund monies, the fund has grown to £648m and is rated AAAf/S1 by Fitch. It has become increasingly popular with external clients, and today approximately 55% of the fund is managed on behalf of external clients, while the remaining 45% comprises Canada Life assets. For our external clients this provides the stability of investing alongside a life company – a natural long-term holder of cash – together with a well-diversified pool of fellow cash investors.
Diversity is, of course, also paramount in controlling portfolio risk exposures. Since launch we have maintained an approved counterparty list comprising over 140 names, from which we have consistently had an evolving cohort of approximately 70 names within the fund at any one time. Collectively, our counterparties have an average long-term rating of low AA to high AA-. At the same time, the number of holdings in the fund has consistently been between 120 and 150.
No stranger to difficult markets
Mid-2017 was not an ideal time to launch a sterling liquidity fund, one year after the Brexit referendum and into a lower-for-longer interest rate environment. Good sources of yield were increasingly scarce and the temptation to raise risk and reach for yield was strong. Over the following years we experienced rates flat-lining, two rate rises that created a short-end rate curve, and then rates falling to historic lows as a result of Brexit and COVID-19.
Such different circumstances called for flexibility in our asset choice, a degree of nimbleness and a prudent approach to credit risk. These have served us well and will continue to be key elements of our approach to managing liquidity as we prepare for markets which we fully expect to be no less tumultuous.
We firmly believe that having a highly liquid, high-quality portfolio is the only way forward and we continue to search out assets that meet these criteria. The shift in sentiment that accompanied bond re-pricing this year has enabled us to re-evaluate the options available once again and add some relatively higher-yielding assets.
In summary, with so much unclear at this time and no imminent rate movement expected, we continue to add select long-dated fixed income bonds and are also increasing exposure to floating rate notes to benefit from any movement in SONIA associated with rate rises.
The LF Canlife Sterling Liquidity Fund is a UCITS scheme and a standard variable net asset value (VNAV) money market fund (MMF). The MMF is not a guaranteed investment, nor does it receive external support to guarantee its liquidity. Unlike bank deposits, investment in MMFs can fluctuate and investors’ capital is at risk.
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The information contained in this document is provided for use by investment professionals and is not for onward distribution to, or to be relied upon by, retail investors. No guarantee, warranty or representation (express or implied) is given as to the document’s accuracy or completeness. The views expressed in this document are those of the fund manager at the time of publication and should not be taken as advice, a forecast or a recommendation to buy or sell securities. These views are subject to change at any time without notice. This document is issued for information only by Canada Life Asset Management. This document does not constitute a direct offer to anyone, or a solicitation by anyone, to subscribe for shares or buy units in fund(s). Subscription for shares and buying units in the fund(s) must only be made on the basis of the latest Prospectus and the Key Investor Information Document (KIID) available at https://www.canadalifeassetmanagement.co.uk/
Canada Life Asset Management is the brand for investment management activities undertaken by Canada Life Asset Management Limited, Canada Life Limited and Canada Life European Real Estate Limited. Canada Life Asset Management Limited (no. 03846821), Canada Life Limited (no.00973271) and Canada Life European Real Estate Limited (no. 03846823) are all registered in England and the registered office for all three entities is Canada Life Place, Potters Bar, Hertfordshire EN6 5BA. Canada Life Asset Management Limited is authorised and regulated by the Financial Conduct Authority. Canada Life Limited is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority.
Expiry on 26/05/2022
 AUM as at 30/04/2021