A key requirement of cash management funds and ETFs is that they remain highly liquid

Consumer "cash" and "enhanced cash" funds are attracting APRA's attention as regulators increase scrutiny of specific words and terms used by financial services professionals.

The Australian Prudential and Regulatory Authority (APRA) believes these terms could mislead superannuation investors.

APRA deputy chairman Helen Rowell said the regulator had "identified examples in the industry where 'cash' investment options appear to include exposure to underlying investments that would not generally be considered cash or cash-like in nature".

In some instances, super funds had invested that money in riskier corporate bonds, credit-default swaps, loans and other credit instruments and hybrid debt instruments.

Several Australian providers offer "enhanced cash" or "cash" funds investing in debt securities such as government and corporate bonds, which can rise and fall in value depending on movements in interest rates and financial markets.

Other assets often held in similarly named funds include corporate floating rate notes (FRNs), asset-backed and mortgage-backed securities, and in some cases, derivatives.

A few prominent examples include the Perpetual Cash Management Fund, the Vanguard Cash Reserve Fund, AMP Enhanced Cash, and the NAB-owned Antares Enhanced Cash Fund.

Morningstar's Emma Rapaport provided a different perspective on managed fund naming conventions in a recent article.

Morningstar urges caution

"Cash is the most defensive part of an investor's portfolio, and we think something is either cash, or it isn't. This was one reason why Morningstar disbanded its 'Enhanced Cash' category some years ago and reclassified these funds into either cash, diversified credit, short-term fixed interest or other categories," says Morningstar's associate director, manager research at Morningstar, Alex Prineas.

He says investors should avoid assuming that just because a fund has a stable or fixed unit price, this doesn't necessarily mean it is cash.

"To understand a fund, it's important to look at the portfolio. For example, many mortgage funds had a unit price generally fixed at $1, but in the wake of the GFC, investors in many of these funds had their money locked up for years and some mortgage funds even suffered capital losses," Prineas says.

Rule of thumb: simplicity

"The old philosophy of 'if something is difficult to understand ourselves, how will we explain it to the client' rings true. Cash, in their eyes, means no risk," says Scott Keeley, a financial planner with Wakefield Partners.

He says clients usually think "enhanced cash" refers to the use of term deposits and other cash products to improve returns. "They are surprised to hear that bonds and bank bills and other fixed interest securities are used to enhance the returns, particularly as many clients understand there is some risk to these types of investments," says Keeley.

"The difference in return between cash or cash enhanced managed funds, and the bank account option is negligible, but comes with lower risk. The availability of term deposits on most platforms now negates the need to pursue cash enhanced options," says Keeley.

Another financial planner, James Ridley with Atlas Wealth Management, largely agrees: "I think the clear downside is that there is a lack of transparency for investors to know what their underlying holdings are through the ETF or managed fund."

Doubts over liquidity

A key requirement of cash management funds and ETFs is that they remain highly liquid – and corporate bonds largely do not belong in such portfolios, according to Bill Prendergast, senior portfolio manager, Atrium Investment Management, which runs cash and fixed income portfolios.

"There is very little room in a cash management account to take interest rate or credit risk, and no ability to take liquidity risk," Prendergast says.

"As seen during the GFC, access to liquidity for cash accounts is paramount, and investment in illiquids – and at times of stress many parts of the bond market can become less liquid – could prevent investors from accessing their funds at short notice."

Prendergast believes anything greater than 12 months to maturity "would likely be exposed to price volatility and lower liquidity in a cash management portfolio, and therefore would be unlikely to be suitable for such a fund".

"Changes within the banking regulatory framework highlight that even term deposits are not completely liquid and this needs to be considered when determining the true liquidity of these funds," he says.

"The key focus needs to remain on access to liquidity under all conceivable market scenarios, and in our view this places a high degree of importance on cash assets, highlighting that these funds should be first and foremost focused on risk, rather than seeking higher returns."

A changing interest rate environment also affects the suitability of various assets within such funds.

"When higher interest rates come, which they inevitably will, some of these cash or enhanced cash managed funds will suffer," says Atlas's Ridley.

"Australia has been lucky with 23 consecutive months of unchanged interest rates, but with an ever-changing property market, I think interest rates will change in the near future."

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Nicki Bourlioufas is a contributor for Morningstar Australia.

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