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Idea for a new type of fund

UNC’s entrepreneurship competition, the Carolina Challenge, is coming up. I am no longer a student, but in the spirit of entrepreneurship, I had an idea for a new type of financial product.

It will be a new type of money market fund. When you deposit cash at a bank, the bank loans out some of the cash, and the rest (not including reserves) is invested in highly-liquid funds called “money market” funds. These funds typically buy extremely short term debt with time periods ranging from 90 days to 24 hours, like US T-Bills and short term corporate debt. Those kind of instruments are very liquid, so the bank can sell out of the fund and convert to cash rapidly to handle day to day inflows and outflows from the bank.

What could be improved

One problem with this system is that it deals entirely in the local currency. The Dollar has rallied somewhat against the Euro over the past few weeks, but in my opinion, there is still a significant amount of potential weakness. Deficits are still high, and the Federal Reserve has kept the money supply at very high levels. The Dollar may be rallying now from investors fleeing the Eurozone and since the US Dollar is historically considered the “safe” currency, but this may not last. Investors with a large cash position should consider diversifying the currencies that they hold their cash in.

Alternative

Investors could look to money market funds in other countries to hedge against currency risk. For example, if they believe that the Canadian Dollar will appreciate relative to the US Dollar, they could buy into a Canadian money market fund.

A problem is though that this will mean that the investor will have to spend a great deal of time analyzing macroeconomic trends and political trends in order to figure out which currencies to pick. This could be a problem for mutual funds, who want to focus mainly on picking stocks, and just want a money market fund to “park” cash in without worrying about it.

My solution

My solution then is to create a new type of money market fund that is pre-diversified across multiple currencies. To my knowledge, no such fund currently exists. There are money market funds that are diversified across different asset classes, like having a mix of both government and corporate debt, but to my knowledge, none are diversified across borders.

Currencies to invest in could be chosen using some kind of predetermined criteria:

  • Current account surpluses (or deficits)
  • The country’s government debt and deficits, if any
  • Political stability
  • Money supply
  • Inflation and expected inflation

The advantage

The advantage to this kind of system would be that it gives the same high liquidity of a regular money market fund, but it could also give the investor some alpha.

This kind of fund is probably not appropriate for banks that need to handle day to day transactions in their local currency, but it is worth exploring for sophisticated investors like mutual funds or hedge funds. More research should be conducted on this topic.

-Alex Cook



Disclosure: None