S&P - Public Finance Criteria (2007). - The Global Clearinghouse

Government Investment Pooland $1.005. Because funds can pay out $1.00 onshares that may actually be worth as little as$0.995, the remaining participants in the fundabsorb the difference. This is referred to as dilution;redeeming shares at a price above their actual marketvalue is diluting the value of the fund’s holdings.This situation could be significantly worse forstable NAV GIPs that do not employ frequentmarking-to-market because the pool’s true valuecan drop well below $0.995 without it being recognized.In analyzing the pool’s participant base,Standard & Poor’s examines the expected redemptioncharacteristics. It then models hypotheticalinterest-rate movements in conjunction with reasonablysevere levels of redemptions in order to judgethe potential dilution a fund may experience.Standard & Poor’s expects that a fund’s investmentsshould be tailored to its potential cash flow needs.For pools with a potentially volatile participantbase, a more conservative approach must be takenwith regard to WAM and liquidity.Shareholder characteristicsA money market fund’s market price exposure isalso affected by the flow of money into and out ofthe fund. Unexpected redemptions have a directinfluence on a fund’s NAV. Therefore, Standard &Poor’s reviews the characteristics of each fund’sshareholder/participant base to determine thepotential impact of share redemptions on marketprice exposure. This review of shareholder constituencyencompasses consideration of the number,average holding size, type of investor, historicalasset volatility, and the relationship managementhas with the participant. The proportion of voluntaryversus involuntary investors and the past historyof redemptions are also examined. Pools withhistories of volatile subscription and redemptionpatterns are expected to have shorter weightedaverage portfolio maturities.Portfolio valuationA Standard & Poor’s stable NAV pool or moneymarket fund rating directly addresses the ability ofa fund to maintain a NAV that does not deviate bymore than one-half of 1%. For a fund to effectivelystay within this narrow range, accurate pricing ofits securities is essential. Most stable NAV pool ormoney market fund instruments are highly liquidand easy to price. However, some complex, structured,and derivative securities present pricing difficulties.Complex and derivative securities often lackefficient, liquid markets. Trading in these securitiescan be infrequent, creating varying price quotesamong dealers and wide bid/ask spreads.The prices of these types of securities may bedetermined in a variety of ways, including dealerquotes, matrix pricing formulas, spreads to benchmarksecurities, pricing services, or even by thefund advisers themselves. All of these methods havedrawbacks. Dealer quotes on thinly (infrequently)traded securities often represent indicative pricinglevels and rarely constitutes an actual bid to purchasethe security. Matrix prices, pricing servicequotes, and spread calculations are not based onactual trades, and do not represent a price at whichanyone actually offered to purchase the security.These methods calculate a hypothetical price that isnot verifiable. Pricing by fund managers oftenoccurs when the manager either disagrees with theother pricing methods or holds securities so uniquethat other pricing methods are inadequate. Clearly,even if the fund manager can determine fair valueprices based on in-depth analytics, it is far fromcertain that any buyers are willing to purchase thesecurities at or near those prices.Before purchasing complex, derivative, or otherwiseilliquid securities, portfolio managers shouldcarefully examine the pricing issue. It is necessaryto evaluate the number of available pricing sources,with an eye toward identifying material discrepancies.Portfolio managers should also be aware ofpricing methodology, and should compare theresults to recent trading activity. It is inadvisable fora fund’s manager to solely accept the calculations ofa security’s issuer or dealer in determining the valueof an investment. This information may be eitherhighly biased or based on inaccurate assumptions,or both. Portfolio managers should not only be ableto determine their own fair value for securities thatare difficult to price, but need also to consider themarketplace for each security and the potentialvolatility that can be caused by inefficient marketpricing. If a fund adviser lacks the ability to assessthe potential market behavior of a security with ahigh degree of comfort, the security should not bepurchased for that money market fund.Net asset value (NAV) monitoringShould a fund experience a situation where stabilityof its $1.00 NAV is in jeopardy, there are severalactions the fund may take. These include withholdingdividends, selling securities to realize gains orlosses, valuing the shares at the market rather thanat amortized cost, or waiting out the situation todetermine if the problem is only temporary. In therating process, Standard & Poor’s reviews the formaland informal policies and procedures the fundhas in place to monitor and correct such situations.ManagementThe rating process includes a meeting between thefund’s officials and fund analysts from Standard &Poor’s. Standard & Poor’s evaluates the effectivenessof fund management in implementing awww.standardandpoors.com317