It’s not quite the same or definite as Isaac Newton’s observation on gravity that “What goes up must come down,” but if spreads keep widening between prime money market funds and treasury and government funds, what flows out may flow back in. That’s the view of Kroll Bond Rating Agency, which said in a note that while flows out of prime funds will continue – and accelerate – ahead of coming regulation in October, post-implementation, that money could turn right back around as prime funds get attractive again.
Beginning on October 14, 2016, Securities and Exchange Commission rules governing prime money market funds kick in. These include imposing a floating net asset value regime and also giving funds the ability to block the exits during times of strife with gates and fees. This has cause billions of dollars to exit prime funds and into government funds, which will keep a fixed rate.
The exiting cash is creating the widening spreads, and could be where “prime MMFs will perhaps find their salvation,” the authors of the Kroll report write. As the cash picks up velocity ahead of October 14, “the cost of short-duration funding for credit will continue to widen.” After that, the future will be a little clearer, Kroll said. Prime MMF managers will “see more clearly what their base AUM will be going forward,” after which, returns on the prime MMF funds should increase. “This is expected to occur at the same time the now heavy-AUM government and treasury funds MMF may see their returns continue to contract.”
Then “as shareholders become more comfortable with the floating NAV nature of the prime funds, and are further enticed by a widening of spread between the returns of treasury and government funds versus that witnessed in prime funds, that we should see outflows slow and ultimately reverse,” Kroll said in its note. “While a full recapturing of the AUM lost in prime funds is not expected, a return of up to 25% of the amount lost seems plausible based on what we see and hear today.”
Over the last couple of years, spreads between prime and government and treasury funds have been averaging around 16 basis points, although have recently been as high as 20 bps. According to Kroll, current consensus among fund managers is that spreads could widen to 30 bps but “given current market dynamics, it could very well be much higher.”
The key will be for prime MMFs to hold out until after October.