Published: November 01, 2011
The money market fund sector, for many years a vital cash management support for treasurers worldwide, faces a stiff test. Yields on short-maturity securities are at or near record lows and the supply of high quality debt is tight. US commercial paper issuance has fallen by more than 40% since 2008 to about $1tr today[1], as banks and other issuers have cut their reliance on short-term funding. In Europe, the sovereign debt crisis has squeezed the volume of eligible securities available to money market funds.
Meanwhile, far-reaching new regulations are being considered, intended to reduce the risks associated with money funds even further. But the rules are also likely to limit funds’ yield potential and increase the costs of running them. Capturing the darkening mood, in October a Bloomberg headline declared – with almost Dickensian gloom – that the present was the ‘Worst Time For Money Funds’.
Not so fast. These may not be the best of times, but don’t write off money market funds too early. We have no doubt they will continue to play an important role for many investors. In fact, through all the uncertainty, the stable NAV concept continues to thrive: funds under management for IMMFA members remain on an upward long-term trend, standing at over €450bn in September. Nevertheless, money market funds are evolving, with important implications for the investors that use them.
While we do not know precisely how regulatory changes may reshape the sector, money funds are unlikely to be the one-size-fits-all solution they once were. These investment vehicles will almost certainly have to make more of a trade-off between the three golden promises of security, liquidity and yield.
So how should treasurers adapt to the new reality? First, we think money funds should no longer be considered a homogenous product, with fees and performance the only differentiators. Investors should choose more carefully between them, focusing on transparency and the quality of the investment and research process.
Second, cash is now rightly being viewed as a risk asset class. This is not something to fear: there are opportunities for investors to consider new ways of managing their cash allocations, dividing them between money market funds and other high quality options.
We are already seeing signs that investors will not sit idly by while regulators debate the future of the industry. More of our liquidity clients are considering a wider range of investment options, aware that a wall of cash is chasing fewer high quality securities at the short end of the yield curve.
For example, we are seeing increased investment in debt with slightly longer duration than traditional money market fund securities, such as quality sovereign debt and non-financial corporate bonds. Investors that can weather some volatility are also seeking out opportunities in currently unloved sectors. This category includes the paper of some fundamentally sound global financial institutions in debt-burdened European countries – though in-depth research is needed to identify the most attractive potential risk-adjusted returns.
As they search for new solutions, treasurers and other investors are taking greater control. In the past two years, the number of our liquidity clients that have assets in separate accounts – usually in addition to a money market fund allocation – has risen by about one-third. These accounts give greater flexibility to invest across instruments that have more diverse risk and return profiles than the securities available to money market funds.
Moreover, treasurers are starting to use separate accounts in atypical ways. As a sign of the times, consider this: the treasury department of a US-based multinational of our acquaintance recently made a strategic investment in shorter duration high yield bonds. The portfolio was designed with risk management foremost in mind, focusing on securities with credit ratings toward the upper end of the below-investment-grade rating band. Nevertheless, if proof were needed that a quiet revolution is taking place, surely this is it.[[[PAGE]]]
For most treasurers, money market funds will remain a cornerstone of their cash management activities – and frankly, we do not expect every treasury department to start investing in high yield. And with the money market fund sector searching for a new equilibrium, treasurers will face challenges as they seek the right balance between security, liquidity and yield. But there is every reason to be optimistic. Though many questions remain unanswered about the future of money market funds, one thing is clear: the uncertain environment has unleashed a wave of creative thinking among treasurers that is leading to new solutions.
Whatever regulators and politicians ultimately decide, the market will find a way to solve its own challenges. It always does.
Note
[1] www.federalreserve.gov
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