Credit quality is evaluated by looking both at assets individually and in aggregate. For individual assets the type, credit quality and tenor are relevant characteristics. Each agency has a methodology for evaluating the portfolio risk in aggregate, typically this is a combined measure of risk and duration which will seek to identify whether undue risk is being taken through the way in which these factors are managed.
Fund managers add their value by optimising to ensure that portfolios do not experience credit events, have sufficient liquid resources to meet investor redemption requirements and do not lose value due to changes in interest rates and credit spreads. The rating agencies challenge portfolio construction by analytical review including stress testing which explores the behaviour of the portfolio in hypothetical adverse market conditions.
Since money market funds are dynamic entities the ratings are concerned with the strength of the operational framework upon which they are based. This encompasses the operating procedures, risk management and internal controls of the manager, including disaster recovery, but extends to the entirety of the fund company and so also includes the administrator, custodian and trustee and their practices, policies and controls.
Money market funds are required to have at least 10% of their assets maturing the next business day and at least 20% maturing within five business days. Overall the weighted average life (WAL) or final maturity of the portfolio is not allowed to exceed 120 days. The consequence of these requirements is that each fund has a relatively high investment rate. The ratings agencies monitor the maintenance of quality through regular reporting requirements and dialogue with fund managers. Ratings are also subject to annual review which involves on-site meetings with managers.