DR.CHENJIAZI ZHONG

Traditionally, there have been two primary investment vehicles available to store cash: money market funds (MMFs) and bank deposits. Both eliminate mark-to-market (MTM) volatility, removing uncertainty associated with market gyrations via a fixed net asset value structure. This is a great benefit for anyone who has better things to focus on that the daily price fluctuations of their cash.

As the European Central Bank (ECB) expands its balance sheet, excess reserves in the banking system will increase and could eventually push money market yields down toward the floor established by its deposit rate. If that happens, MMFs will technically “break the buck”, eroding capital day by day.

In terms of bank deposits, although they continue to offer investors a healthy spread over MMF yields, returns are rapidly declining, with a lag. Additionally, the bigger concern with bank deposits stems from new regulations, and the counterparty risk that large depositors face is about to soar.

PIMCO European and Global Products introduces a methodical approach to balancing the trade-offs of MTM volatility, counterparty risk and capital erosion. The goal is to limit counterparty risk and reduce the threat of capital erosion, offset by a risk-managed increase in MTM volatility:

• The first step involves projecting cash requirements over time.
• Second, define a set of investments, not in the traditional sense but with a conservative definition of risk: assessing how long it could take for the investment to recover following an MTM drawdown under the worst case scenario.
• Map these investments along a timeline that matches projected cash requirements.