Money market funds thrive despite regulatory storm

Prime money market funds, which maintain a constant net asset value, face an uncertain future as impending regulation in Europe could prompt huge outflows, of an estimated €500bn or half of the sector’s assets under management (AuM).  The European Parliament is likely to insist that constant net asset value (NAV) funds switch to a new floating NAV structure, recording the value of their assets at market value daily, despite heavy lobbying from the industry for a dilution of the measures.

Regulators believe that a variable NAV, that rises and – more critically – falls, makes clear to investors the risks involved in these funds, which are often wrongly perceived as a safe cash alternative. However, further developments in Europe seem unlikely before 2016, when the presidency of the EU passes to the Dutch. 

The Securities and Exchanges Commission has already passed measures requiring money market funds for institutional investors in the US to move to a floating NAV structure  from October 2016, but it has allowed retail products to remain fixed at a dollar a share. The new SEC regime will also impose gates and fees on institutional products to deter a run on the funds in times of crisis. 

It is uncertain how investors will respond to these funds under the new regimes. Arguably, as the underlying investments will remain the same, the change is merely one of labelling, but the liquidity fees and gates pose issues. A question for defined contribution pension funds for instance will be whether they feel comfortable, in view of their fiduciary duty, with the prospect of members facing such measures.

Furthermore, many investors are in Asia, and other regions, and one concern is the new regulation could render these funds unsellable in particular jurisdictions or to certain categories of client. 

So far this year, these funds have been very successful in attracting inflows, increasing their assets in August for the fourth month in a row, rising $113bn, or 4.4 per cent since the end of April, according to ICI’s Money Market Fund Assets report, unusual over the summer period when money tends not to move around. This summer, of course, stockmarkets have been hit by first Greece and then the China meltdown and with the Vix at 40.75, the popularity of a cash proxy is not surprising.

 “We continue to see strong demand for the Euro Liquidity fund and our broader money market fund range from retail clients and corporates to insurers and asset managers,” says Bea Rodriguez, co-head of International Cash Management at BlackRock. “They value the daily liquidity and diversification money market funds provide, in an environment where regulatory change for the banks and low interest rates is making it increasingly difficult to manage cash investments.”

Leonardo Brenna, who has managed the UBS Lux Money Market EUR fund since the launch of the euro, also speaks of significant net inflows from a diverse group, including wealth management clients, institutional clients and European third party fund distribution business. 

The biggest trend has been the switch away from AAA funds to the second ESMA money market category  as they contemplate negative returns, and capital preservation. Variable NAV funds can make 10-15 basis points, net of fees, while AAA funds are losing 7-10 basis points pa.

Amundi manages €159bn in treasury funds, of which €128bn  are in the second category. Since the beginning of the year the asset manager has attracted €30bn of inflows into the second category – two thirds is from France – but the firm is also beginning to see inflows accelerate from outside. 

These funds have met with a lot of success in France and Europe, says Patrick Simeon, head of Money Market at Amundi. “We have benefited from being positioned in the second category where we can extend maturities and have more leeway than the very strict guidelines applied to AAA-rated funds. So we can select lower rated investments and a bigger selection of credit names and therefore have funds that do well compared with AAA funds where real returns are negative.”

The issuers selected are investment grade issuers or equivalent still, while triple A funds are limited to A1, P1 or F1 only, he says.

Meanwhile, several providers, such as Fidelity and Charles Schwab, are using the improved returns on their funds to raise fees again after cutting them in the aftermath of the credit crunch. These moves have been made possible by the potential rate hike by  the US Federal Reserve which in turn is boosting yields on short-term corporate debt and bank certificates of deposit. 

Rising rates used to be what money markets feared the most, says Peter Crane, president of  Crane Data and publisher of Money Fund Intelligence. “But because rates have been so low, funds in both the US and eurozone have not been able to charge their full fees, and are charging only one half or one quarter of what they charged previously, perhaps 0.15 per cent instead 0f 33 per cent.”

Fees are very hard to keep track of, he explains, as they move from day by day, but for funds  returning 0.01 per cent, it is likely that providers are waiving a significant amount in fees, meaning that although gross yields have been inching higher, net yields have not moved. 

Some firms, notably Goldman Sachs, are predicting a big switch into money market funds that invest in US government debt as these funds will be exempt from the new rules. Goldman predicts as much as $450bn will be pulled out of prime funds, slashing their AuM by 50 per cent. 

However, some of those managing cash will surely revert to bank deposits  and admit defeat  in their quest to make returns on their cash balances, and many investors are also taking steps to improve their cash forecasting in an effort to minimise the need to hold extremely liquid funds. 

Furthermore, if the Fed raises rates in coming months as expected, yields on prime money market funds might rise much faster than those on government funds, encouraging their investors to stay put.

“If rates and regulations move together then it is unclear what will happen,” says Mr Crane. “There will probably be unintended consequences. I’m guessing that if rates rise – and this is not a given – the most surprising thing may be lack of movement and that the one half to one per cent generated by CDs [certificates of deposit] and CPs [commerical papers] will be enough of a spread  to make people stay with a floating NAV vehicle. And of course, rising rates themselves are bad for stocks and bond markets.”

Corporate treasurers and large institutions trading other people’s money have mandates that force them to pretend that safety takes precedence over yield, he says, but although people say safety is most important, yield is its own PR agent.

“Because of where yields are, people have become more aware of what it costs to carry cash in their portfolios,” says Menno van Eijk, senior portfolio manager at NN Investment Partners. With strong competition in every asset class and every basis point saved, even on cash positions, increasingly important, there is more emphasis on managing cash and in always being able to have it liquid, he adds.

 “Certainly, there has been a transition over the last few years to a broader investment universe,” explains Mr van Eijk. “Typically a money market fund like ours was for the largest part invested in European financial names and a sovereign or two, and government-related agencies or state-owned enterprises.”

In the credit crisis, financial names were under pressure and recently they have been less likely to accept cash on short tenures, he explains. So NN is bringing in more corporate names and branching out beyond euro and US names to more exotic Asian and Chinese financials and corporates, which are using their branches in Paris, Luxembourg, Sydney and Hong Kong to issue certificates of deposit and commercial paper in euros and dollars.

“The better thing for being a variable NAV fund is that we can more easily invest in regular corporate bonds, which are valued marked-to-market and we can also invest in floating rate notes  without too many constraints in terms of valuations,” says Mr van Eijk. If they are sub-one-year then they are suitable for money market funds, as long as the manager can deal with the pricing volatility on a marked-to-market basis.

The NN fund has invested in sectors such as oils and other names that have been upgraded in the last few years. Around these yield levels people have been forced to adopt different means, in the understanding that any single extra basis point is important, but there is not a lot of low hanging fruit left and liquidity is decreasing, he says.

“In terms of competitive edge, time to market is quite important. An opportunity can be gone in seconds and so you need to move quickly,” adds Mr van Eijk.

The main issue currently is the challenge of finding investment opportunities in the market, agrees Amundi’s Mr Simeon. “This is an issue because the ECB has put so much liquidity into the system that many issuers  have a limited need for funding. We sometimes have difficulties finding interesting opportunities to invest all the inflows into this market. Moreover the best rated issuers issue most of the time at a level that is in negative territory.”

The market has seen some consolidation but the focus on net yields should not mask the reality that these funds are still making money. Indeed, some firms such as Goldman Sachs and BlackRock are launching new government money market funds that will not need to implement an emergency gates and fees system.

“Providers are preparing for the new regulations or filling holes in their product line up, as no one is sure how investors will react,” adds Mr Crane at Crane Data. “So they are putting a bucket in every sector.”  

Balancing risk and reward

The US market for money market funds is retail-oriented, while in Europe the big clients tend to be corporate treasuries and institutions that use the funds for their cash management.

“Broadly speaking, we find clients tend to fall into one of two categories,” says Will Hobbs, head of investment strategy, Europe at Barclays Wealth. “The first is those who require cash because their primary objective is preservation of capital, while the second is a result of asset allocation decisions in their investment portfolios.”

For the former, there is some acceptance that while they might like higher rates of interest on their deposits, it is not possible without increasing risk unnecessarily, he explains. “The solutions here are either to leave the funds in an instant access account, as locking up funds for a longer period typically does not enhance yield, or, for those clients who are keen on high degree of diversification, to recommend purchasing liquidity funds run by one of the major investment houses.” 

For the very risk averse (and larger) clients, there are treasury bills which are technically a risk free asset, although these have a corresponding low yield, explains Mr Hobbs.

 On the other hand, those with multi-asset class portfolios, and thus a longer investment horizon, tend to be more sensitive to low yields. Here, Barclays has sought to enhance low yields by purchasing short-dated high quality bonds – A+ or better – and less than two years maturity. 

“This is not suitable in every case, and is potentially risky if interest rates rise faster than the market’s current pricing, but we believe it offers a good balance of risk and reward especially as inflation is currently subdued,” adds Mr Hobbs.

VIEW FROM MORNINGSTAR: A pricey way of parking cash

The job of European money managers is not getting any easier. The decisions in late 2014 by multiple European central banks to lower their overnight lending rates into negative territory, combined with expanded asset purchasing programmes in Europe, have pushed short-term government bond yields well below zero in several countries. 

Money market funds (MMFs), which strive to maintain a fixed net asset value by balancing yield with liquidity, are finding fewer attractive options. The average yield for Morningstar’s EUR Money Market category has fallen sharply, from 86 basis points in mid-2013 to roughly 16 basis points in July 2015. Given the median fund imposes an ongoing charge of 26 basis points, investors are paying a hefty price to park cash. Managers are also flirting with new risks as they try to scrape together a return for investors – the ECB has noted an increase in the use of FX swaps by MMFs as eurozone managers aim to capture the higher yields on short-term dollar and sterling debt.  

In 2013, European money market funds saw outflows as investors sacrificed daily liquidity for the relatively higher yields of short-term bond funds. Since early 2014, however, renewed investor interest has sent €65bn back into MMFs denominated in euros, Swiss francs and sterling. 

That is partly explained by foreign financial institutions looking to use the weak euro as a funding currency. But it is also a sign investors here have fewer viable options – more and more custodian banks are charging their clients to deposit cash. For investors who do park their cash in a mutual fund, checking the price tag is paramount. With yields barely positive, every basis point can make a difference.  

Shannon Kirwin, senior fund analyst, Morningstar