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Investment Management

Trickle Back to Prime MMF to Continue in 2018: Fitch

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November 15, 2017

As government funds face supply issues, prime and alternatives to grow.

financial system softwareCash will continue to trickle back to US prime money market funds in 2018, according to an outlook from Fitch Ratings. Alternative investments like separately managed accounts will also see growth in 2018 and beyond.

“Fitch anticipates a portion of money to move back to US prime funds from government funds throughout 2018,” Fitch wrote in its report. “However, the amount and rate at which money can return to prime funds will be hindered by the small size of the funds that remain.”

According to the Investment Company Institute, cash held in prime institutional MMF was $449 billion as of November 9, 2017 down about a trillion from 2015 when the MMF rules were announced. Cash in government institutional funds at $1.5 trillion, roughly the reverse of levels in 2015.

The start of a move out of prime funds and into government funds was in 2015 after the Securities and Exchange Commission announced it would implement MMF regulations in 2016 that included liquidity fees and gates along with a floating net asset value. Government money market funds were allowed to keep fixed NAV. Fitch says that “while a portion of the assets that moved from prime to government funds as a consequence of 2016’s reforms is likely to remain there permanently,” it thinks there is a sizeable investor base “that moved to government funds as a temporary defensive position and will move back to higher yielding products over time as they assess their cash requirements.”

“Prime funds are expected to become increasingly attractive in 2018 as yields continue to rise, especially versus brokerage sweep accounts where near-zero percent rates persist,” Fitch says. Following the reforms of 2016 fund managers have reduced liquidity (although have kept it above the 30% threshold required by new rules) and benefited from a few rate hikes. Fitch says yields on prime money funds have been “edging over 1.00% in some cases” and that the prime to government spread is at 28%, although that’s not seen widening too much more going forward.

Meanwhile Fitch says investors will continue looking for yield by “considering alternative liquidity products in addition to moving cash back to prime funds” owing to positive yield differentials between the various products. Depending on what investors have in mind, there are plenty of attractive products, including short-term bond funds, private money funds, insured cash accounts (like StoneCastle’s FICA) and SMAs.

While prime and other funds will enjoy inflows, supply shortages of high quality, short-term US Treasuries, agencies and repurchase agreements will hamper government funds, Fitch says. The rating agency also says concerns about debt ceiling debate, which has caused the Treasury to ramp up its bill supply through the end of 2017, will also be a challenge for government funds. “While near-term fears of a possible default are eliminated, the debt limit concerns will need to be confronted again, likely in early 2018,” Fitch says.

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