By Ted Howard
Despite recent small gains, the overall decline in prime fund balances since new regs were introduced in October 2016 means it could be a tough 2017.
After the 2016 money market fund regulations took effect, prime money market funds, which had been the go-to vehicle for institutional operational cash, became not so “go-to” anymore.
Of the new MMF regs implemented last October, liquidity fees and gates were the main concern of institutional investors and were the primary reason for their decision to move into government money market funds, which still will carry the fixed net asset value. Following the rules implementation, institutional flows from prime money market funds into government funds were higher than consensus expectations and exceeded a trillion dollars. Prime funds are a fraction of the size, now well below $300 billion, and the funds have been de-risking due to outflows driving down yield.
A recent survey of both of the NeuGroup’s Treasury Investment Managers’ Peer Groups (TIMPG and TIMPG2) showed that more than 80% of the members moved from prime funds to government money market funds.
For investors that took a wait-and-see approach, moving into government funds temporarily with the expectation of moving back to prime funds in 2017 will likely be disappointed. First, as mentioned, prime fund sizes are a fraction of the market value. Most investment policy statements require the investment not to exceed a certain percentage of the total market value of the fund. Smaller funds sizes will mean less can be invested within each fund. Also the number of prime fund open funds has decreased dramatically.
But where do investors go in 2017? The options are limited. Investors are going to need at least double the yield differential (40bp) to consider moving back. Investors have few choices going forward, and can select a choice of either moving back to prime money market funds, finding alternative options to money funds, or staying where they are (in banks or short-term funds).
Investors will thus have to look at alternatives such as direct investing in the cash market, separately managed accounts or other short-term solutions. One product, the Federal Insured Cash Account (FICA) from StoneCastle, offers next-day liquidity with no transaction fees, or redemption gates. With the recent rise in rates in conjunction with less of a demand for non-government securities in the short end, these could be attractive investment options. For investors that can segregate the operating cash that doesn’t need daily liquidity, a short-term bond fund or cash private placement vehicle will become attractive options.
It is expected that the yield differential between government money market funds and non-government options will force investors to reconsider this “temporary” decision. There is still much uncertainty in the cash market. How will MMF reform change the dynamics of the short-term fixed-income market? What is going to be left of prime money market funds? Balances have continued to erode since the new rules went into effect. So 2017 will definitely be the proving year for prime.