High Interest Rates Lead to a Renaissance of Domestic Investment Funds

Still lower interest rates on term deposits in Croatian banks compared to the western members of the Eurozone are encouraging a sort of renaissance of domestic investment funds, but exclusively of one type – bond funds with maturity. Given that the financial regulator recently approved the establishment of two money market funds, it remains to be seen whether we will soon witness a significant return of this once very popular type of investment fund.

At the beginning of the week, trading began on the Zagreb Stock Exchange for a new investment fund whose shares are traded on the stock exchange (ETF) introduced by InterCapital Asset Management (ICAM). The fund named InterCapital Euro Money Market has seen a solid response from investors, having collected more than 575 thousand euros in turnover in the first three days of trading.

Approval for the establishment was also granted last month to the money market fund of Eurizon Asset Management (formerly PBZ Invest) named Eurizon HR Cash. It will primarily invest in deposits in the Croatian money market, but the prospectus also anticipates investments in the markets of Germany, France, the Netherlands, Austria, Italy, or Spain.

Let us recall that for many years, money market funds were the most popular type among local investors in investment funds. According to data from the Croatian Financial Services Supervisory Agency (Hanfa), the assets of money market funds at the end of 2018 amounted to 7.1 billion kuna, out of a total of 19.1 billion kuna.

Disappeared from the Scene

However, money market funds abruptly disappeared from the scene in 2019 with the enactment of the Regulation on Money Market Funds, which imposed significant requirements on management companies for managing this type of fund. Namely, the Regulation prescribed additional and stricter requirements for money market funds, primarily regarding investment policy and asset valuation.

The requirements for maintaining liquidity were also tightened, in case management companies suddenly faced a large number of investor requests for withdrawals, and they had to meet strict requirements for diversifying their portfolios. Of the 21 money market funds that existed at that time in the Croatian market, 19 requested re-registration as short-term bond funds. Only one fund – managed by the then Slovenian company Alta Skladi – requested to continue operating ‘as before’, but that fund was also shut down by the end of 2021.

With the then zero interest rates and the burden of demanding regulations, money market funds would generally deliver negative returns, so their re-registration was a business-logical move. However, with the current record-high interest rates of the ECB, the situation is changing dramatically. This thesis is confirmed by Hanfa, which emphasizes that the regulation governing the operation of money market funds is stricter compared to other investment funds, but they believe that the (non)existence of money market funds in the last two years has been primarily influenced by market conditions, specifically the period of low interest rates.

– With the rise in interest rates, interest in this type of fund has re-emerged – explain the regulators.

If we look at the current level of nominal interest rates, the moment for establishing money market funds is favorable, and we expect investor interest in this type of fund, says Hrvoje Krstulović, president of the Association of Investment and Pension Funds of the Croatian Chamber of Commerce.

– A significant number of factors influenced the exceptional popularity of money market funds after the 2008 crisis, one of which is the involvement of a large number of investors, companies, institutions, and citizens. Money market funds have their significant place in liquidity management and are appearing for the first time after the enactment of the EU Regulation on Money Market Funds, thus complementing the range of funds and products available to investors – says Krstulović.

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Lider Investicijska konferencija 2023. Panel 2. “Izazovi investiranja”: Hrvoje Krstulović

foto Ratko Mavar

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However, in addition to reviving money market funds, this year we are witnessing a real explosion in the establishment of bond funds with a limited duration. The trend of establishing funds with maturity began back in 2022. Last year, Hanfa issued approvals for the establishment of 11 such funds, while in the first half of this year, approvals were issued for the establishment of another 11 such funds. These are funds with a ‘duration’ of between two and five years, and this year they have been established by Erste Asset Management, Eurizon Asset Management, OTP Invest, Raiffeisen Invest, and ZB Invest. Among the funds approved in 2023, the targeted annual return ranges from 1.57 percent (as stated in the prospectus of the Eurizon HR Target 2025 IV fund) to 3.50 percent that OTP Multi USD 3 intends to achieve.

It can be said that such funds primarily target investors who found investing in government bonds interesting. Namely, the payment of money into funds with maturity is only possible while the public offering is ongoing, and investors are advised to hold shares for the entire duration of the fund to achieve the targeted return. As explained by Hanfa, management companies in the case of such funds usually try to structure investments in a way that minimizes the potential loss of principal (so-called funds with protected principal).

– However, it is important to note that such funds do not imply any guarantees unless some form of guarantee is explicitly stated. The mentioned characteristics of these funds, along with clients who are not inclined to higher risk, significantly influence the popularity of these funds – assess the regulators.

Opportunity for Banks

Judging by the numbers, the response from investors has not been lacking. The latest available monthly report from Hanfa for September shows that in the category ‘others’ – which includes bond funds with maturity – there are 539.14 million euros in assets. Only open bond funds with an indefinite duration have more assets under management, 830.5 million euros.

In financial circles, it can be informally heard that a partial reason for such a wave of establishing bond funds with maturity lies in the business policies of large banks, which own leading investment fund management companies. By offering alternative low-risk products, which are also acceptable to investors who prefer the security of term deposits, banks partially alleviate the pressure from the public (and politics) to raise interest rates on deposits more quickly, especially those with longer maturities.

Financial analyst Darko Brborović emphasizes that the logic of management companies regarding bond funds with maturity is the same as with money market funds – interest rates are at a sufficiently high level for managing these funds to be profitable. Moreover, almost all mention in their prospectuses the possibility of investing in the financial markets of other Eurozone members, as well as the USA.

– The growth of yields abroad is more radical than here – emphasizes Brborović.

What has been noticeable for some time is that there are no new equity funds – except for ICAM’s ETF that tracks the movement of the Romanian stock index BET – this year at all. In this type of investment fund, at the end of September, there were 339.5 million euros in assets, which is 32.2 percent more than in the same period last year. According to Darko Brborović, as long as there is such a favorable tax treatment of investments in real estate in Croatia, there will be no greater interest from citizens in investing in financial instruments, especially stocks. Therefore, investment fund management companies have no motivation to expand their offerings in that direction.

Hrvoje Krstulović says that despite very good returns in the stock markets this year, investors still prefer more stable returns and predictable investment outcomes offered by bond funds with targeted returns until maturity.

– We expect an increase in investment plans (regular monthly contributions) in equity funds in the next period, and through such investments, an increase in the assets of equity funds, and consequently an increase in the offer of various equity strategies. Investing through investment plans in equity funds offers a reasonable expectation of participating in the growth of stock markets (economies), partial protection against inflation, and lower sensitivity of the expected portfolio in different market conditions. Throughout more developed countries, this is one of the usual forms of long-term savings in the capital market for citizens – emphasizes Krstulović.

Hanfa also assesses that management companies have clearly not identified the need for such products. – Obviously, the market conditions and investor interest have favored the establishment of other types of funds, such as the previously described funds with protected principal and money market funds. In the context of elevated interest rates and the risk aversion of domestic investors, these funds are clearly more interesting to investors – conclude Hanfa.