Investing With the Herd: Money Market Edition

FT: Huge growth in China’s money funds poses risk

Robert Pozen, senior lecturer at Harvard Business School and former chairman of MFS Investment Management, the oldest US mutual fund company, fears investors are being drawn to the high interest rates without any understanding of the risks.

The funds offer high interest rates, he says, but “they are not explaining that in many cases this type of paper is not top quality. This is essentially what we would call primary junk funds in the US — paper that’s usually below investment grade, fluctuates daily in terms of interest rates and from time to time defaults.

“The big risk is selling to relatively unsophisticated investors over the internet who probably do not know what they are getting into. There is a real possibility of loss here.”

Not probably. They don't understand it. Most Chinese savers think it's a workaround where the money funds are getting a better deal from the banks. They do not understand it is a fund and the 1 yuan share price is not guaranteed. If the herd ever was scared enough to exit en masse, there would be chaos.

Rating agency Fitch has highlighted the level of retail investor cash flowing into the funds as a cause for concern. It noted in a report written last month that yield-hungry retail investors are prone to herding patterns of behaviour when markets become stressed, which could lead to “periods of mass fund exodus”.

Herd behavior is similar all over the world, but in China there is less opposition to following the herd because of the culture. Take the stock bubble, where uneducated rural farmers are engaged in stock speculation less than 1 year from the start of a major bull market. There are 150 million people and 578 billion yuan in Alibaba's Yu E Bao, a fund that did not exist two years ago. People believe their money is, if not guaranteed, at no risk of loss. There are daily and monthly withdrawal limits on the funds, but if the herd decided to exit, it would overwhelm Alibaba and the market.