The Allan Gray Money Market Fund invests in debt instruments (or 'IOUs') which oblige the issuer of the IOU to repay a fixed money amount on a specified date within the next year. If the issuer were to go 'bankrupt' and default (in other words not be able to pay the full amount due when it is due) the Fund and its investors would bear a loss.

One way in which we try to address credit risk is to invest the Fund in a diversified portfolio of debt instruments issued by a range of issuers, so that any potential losses arising from the default of any one issuer will be constrained to a limited portion of the Fund?s portfolio. Indeed, the regulations governing the Fund restrict exposures to different types of issuers to limits which enforce some diversification of the Fund?s holdings.

Of course, the benefits of diversification will be tempered if the default of one issuer sets off further defaults by other issuers in a domino-effect crisis. In the event of a systemic crisis like this, governments around the world have typically stepped in to shore up and stabilise the financial system (as has happened in the US and elsewhere in 2008).

Obviously, some issuers are more at risk of defaulting than others. Typically, these 'riskier' issuers have to pay a higher interest rate on their debt to compensate investors for the extra risk. Assessing whether or not this higher interest rate is sufficient compensation for the extra risk is inherently subjective and it depends on one?s own assessment of the likelihood of uncertain future events. There is no way to assess the right or wrong answer at the time of investment ? investors in any debt instrument need to exercise their own judgement as to whether there is sufficient potential reward for the credit risk.

When managing the Money Market Fund, we have a very low risk tolerance as we are mindful that the objectives of capital preservation and liquidity are paramount for investors in the Fund. We believe the Fund is very conservatively positioned, with 27.4 percent of the Fund invested in government or parastatal securities, 15.7 percent in corporate paper backed by multinationals with the same or higher credit ratings than the South African government and 56.9 percent on deposit with South Africa?s major banks.

Extreme circumstances can heighten liquidity risk

In most circumstances investors in the Money Market Fund can give one day?s notice of their intent to withdraw all their funds, but we do not invest the entire Fund on call deposit as we think it unlikely that all the Fund?s investors would suddenly want to withdraw all their funds on the same day. By investing in longer-dated paper we can improve the yield earned by the Fund and its investors.

However, in extreme circumstances (such as were experienced in the US money markets in 2008), withdrawals can be unexpectedly large and this may force the Money Market Fund to sell its longer-dated paper in order to fund the withdrawals. If this paper is sold at a loss (as there may be other money market funds all trying to sell the same paper at the same time), then that loss will be borne by the Fund and its investors.

How we alleviate liquidity risk

There are several ways in which we attempt to mitigate liquidity risk:

• Maintain a buffer

  First, we structure the Fund?s investments so that there is a relatively smooth flow of maturities for funding withdrawals in the ordinary course. We also maintain a buffer on call deposit to fund a certain level of unusual withdrawals.

• There is a plan in place to fund withdrawals

  Secondly, under more extreme circumstances, we have the right to borrow up to 10 percent of the assets of the portfolio in order to fund withdrawals and have banking facilities in place should this be necessary. This allows us to buy some time to realise assets and reduces the risk of the Fund being forced to sell investments at short notice which would prejudice the remaining unit holders.

• 'Ring fencing' protects remaining investors from large withdrawals

  Finally, we have the right to 'ring fence' large withdrawals. What this means is that should the Fund experience net withdrawals equal to more than five percent of its assets on any one day, we are allowed to set aside a representative five percent 'slice' of the portfolio and realise the investments in an orderly fashion over a period of time and pay the withdrawing unit holders out of the proceeds. This means that withdrawing investors may wait for more than the customary one day to receive their cash, but those investors remaining in the Fund are protected from the consequences of a fire-sale.

Understand your investment risks

This article is not an attempt to either encourage or discourage investors from investing in our Money Market Fund. But, after a year in which the Allan Gray Money Market Fund has been one of the top-performing funds in our unit trust suite, we thought it appropriate to emphasise that, although the Fund does avoid stock market risk, it carries its own unique set of risks which in an extreme scenario could result in losses for investors in the Fund. The Allan Gray Money Market Fund is not a risk-free investment.