With the money market fund rules set kick in just two short weeks, it almost seems like there couldn’t be any more money left to exit prime funds but there is, according to a viewpoint from the Investment Company Institute.
“Many large money market fund sponsors have announced the dates on which they will implement floating NAVs, ranging from October 1 to October 14,” writes Sean Collins, a senior director, industry and financial research, at ICI. “So a natural question arises: How much more money could shift from prime to government funds by October 14? Ballpark estimates by industry participants suggest the flow could total anywhere between $200 billion and $400 billion.”
Mr. Collins adds that the estimates at the top-end of the range “are not implausible.” He says that as of September 21, prime MMFs still had assets of $669 billion, including both institutional and retail. Over the course of 2015, assets of prime and tax-exempt money market funds have lost $910 billion in cash, with a lot of it — roughly $872 billion – going into government MMFs.
So far those outflows and the corresponding inflows into government MMFs has going smoothly and by most measures, and Mr. Collins says that should continue. One reason is prime funds have been preparing by making their portfolios very liquid – the weighted average maturity on prime funds was 16 days as of September 20, 2016. This means there is a lot of cash and other very short-term assets in the funds, which will be available to meet redemption demands.
Regarding the flows going to governments, Mr. Collins says the funds should be able to handle continued inflows for three reasons:
1. The Treasury appears set to continue adding to the supply of Treasury bills, in part to fund a significant rise in the Treasury’s cash holdings.
2. Federal Home Loan Banks (FHLBs) have increased their issuance of floating rate notes (to help fund FHLB advances to banks), which government money market funds can hold.
3. Government money market funds can place dollars with the Federal Reserve’s reverse repo (RRP) facility; this facility allows money market funds to make collateralized overnight “loans” to the Fed, earning interest on those loans.
Meanwhile, Mr. Collins says the long-term outlook for prime funds could be brighter do to attractive yields. “Higher yields should prove attractive to other market participants, drawing them into the commercial paper market,” Mr. Collins says. Another reason funds may return is comfort level, Mr. Collins says. If after a while market participants see how the funds perform under the new regulatory regime – and this assumes the funds are able to remain steady at the dollar level – they will be more willing to use prime funds again.
“[I]f over time investors learn more about how funds will operate under the new rule and realize that funds will only impose fees and gates under extreme conditions, they may reconsider prime funds,” Mr. Collins says. “If so, prime funds might themselves be able to boost their holdings of commercial paper and buy longer maturities.”
But for now, the bucks won’t stop leaving prime funds. Mr. Collins sees money continuing to move even after the October 14 rules kick in. “That’s because retail investors, who can remain in stable $1.00 net asset value (NAV) prime and tax-exempt retail funds after October 14, may nevertheless adjust to the ‘new normal’ by continuing to migrate to government money market funds, where they can avoid any potential for fees and gates,” he says. “Also, regulations encouraging banks to ‘borrow long’ aren’t going away.”