As a result of this “liquidity event that turned into a pricing event,” the supply-demand relationship in credit markets has permanently changed for the foreseeable future, Korber says. “There was a leveraged group of buyers who will not reappear, as they have turned into a distressed-selling group. Markets will take time to adjust to this.”

He says that once the market has absorbed some of the credit ‘overhang’ created by forced sellers, spreads will contract, but not to the narrowness of those before the crunch. “Once these issues have cleared the price of credit will shift and spreads will remain wider. I wouldn’t be surprised if they stayed significantly wider.”

This does not bode well for managers of blended cash and credit funds. The Perpetual credit income fund, an aggressive cash fund which holds more fixed income than cash securities, according to Korber, returned -1.6 per cent for the fourth quarter of 2007. “Now most funds are seeking to have higher cash levels than 12 months ago, when spreads were tighter and you could earn a higher rate of return through credit holdings.” These credit securities are usually domestic residential mortgage-backed securities with an average duration between two and three years, and are in part responsible for the poor performance of cash enhanced funds and the swing in investor favour towards safer bank bills.

BNY Mellon Asset Management has responded to this, and is setting up an Australian dollar “pure” cash fund, with Standish Mellon as the underlying manager. Jonathan Little, chairman of the US$1.1 trillion manager, says this is due to the popularity of cold cash funds in 2007 and the strong performance of cash in the credit downturn. “You’ve had those instances where supposed short-term cash funds have drifted away from their initial benchmarks, added too much risk and been caught out by the credit crunch. So we’re seeing a lot of demand for pure, well-managed cash funds,” Little says. He says that a manager with BNY Mellon, Dreyfus Corporation, received inflows totalling US$75 billion into its flagship cash fund throughout 2007. It holds short-term deposits and corporate debt, of maturities between 30 and 60 days.

The GoldmanSachs JBWere (GSJBW) Cash Fund, ranked equal first among the cold cash funds in the December 2007 Mercer Surveys, is a cash management trust (CMT), comprised mainly of bank bill deposits and built similar to US money market funds. Money market funds are highly liquid, investing in AAA-rated cash securities, Pillai says. Unlike these vehicles, “cash-plus” funds can have between 50 and 70 per cent of their portfolios in floating rate notes, he says. Consequently, they are not so well-placed in the current market. “As a cash manager, you’re a provider of liquidity. And the value of this has skyrocketed,” Pillai says. “You can take advantage of this and time investments for when you think liquidity premiums will be at their highest.”

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