Corporates eventual exodus from MMFs prompts alternatives.
Miniscule yields on money-market funds (MMFs) have prompted corporate treasuries to search for alternatives for years now, and recently approved regulations have crystallized that need. Even if that need hasn’t become dire just yet, a variety of options are unfolding to help corporate treasury executives address it.
The Securities and Exchange Commission finalized MMF reform rules July 23, requiring a floating net asset value (NAV) for institutional prime MMFs, which are not treasury or tax-exempt funds. The rule also gives fund boards the discretion to suspend redemptions for 10 days in a 90-day period or impose a liquidity fee if a fund’s liquid assets fall below 30 percent of its total assets.
Lance Pan, director of research at Capital Advisors Group, said the floating NAV was “unworkable” with most of his firm’s clients, largely technology companies with significant cash holdings, that mostly use MMFs to park cash before sweeping it into higher yielding investments. That’s because fund companies today are unable to provide intraday NAVs, and the funds’ changing values could result in the inability to invest or withdraw funds intraday.
Add to that the uncertainty imposed by the redemption gates, “and it appears to be a lot more work for very little benefit,” Pan said.
Nevertheless, he noted, prime MMFs have actually seen inflows since the rule passed. That isn’t too surprising, given firms have two years to comply with the requirements from the Oct. 14 effective date, and an improving economy is bolstering their cash holdings. There’s little doubt, however, that the days of abundant MMFs guarantying a dollar back for every dollar put it are fading, and institutional investors will have to be much more active in their cash management strategies.
Companies braving the new world of floating NAV will have to monitor their prime MMFs much more carefully, to ensure minimal changes in fund values. The custodians are anticipated to provide customers with tools to aid in that effort, and BNY was early out of the gate with a risk analysis product, announcing the launch of FundIQ a day before the SEC’s final rule.
Clients “can compare fund characteristics against the peer group averages and assign ratings in multiple risk categories for individual funds or across an entire portfolio of funds,” the custodian says.
The products risk analysis framework covers 50 or so risk characteristics in five broad categories, which include portfolio risk, sponsor risk and shareholder risk.
The Association of Financial Professionals’ July 2014 Liquidity Survey found that 27 percent of 740 respondents said their diverse group of companies would stop investing in prime funds altogether, while another 23 percent said they would move some money out of those funds. Brandon Semilof, a managing director at StoneCastle Cash Management, noted those figures suggest somewhere between $200 billion and $500 billion of the estimated $900 billion in prime MMFs, and that’s not counting the impact of the liquidity gates, which the survey did not address.
The other traditional destinations to park corporate cash have been bank deposits and MMFs investing in government bonds. Banks, however, are already sitting on record deposits, and Basel III’s new liquidity ratio make those liabilities increasingly unattractive for them to hold. In addition, there’s insufficient capacity in government MMFs to absorb the expected run off in prime ETFs, and that alternative’s return is practically zero.
“This is forcing treasurers to become more active, spending more resources on expanding and enhancing the vehicles they can utilize for their cash management strategies,” Mr. Semilof said.
When the Reserve Fund’s share price fell below $1 during the financial crisis in 2008, it put the fear of MMFs’ “breaking the buck” into institutional investors’ hearts. StoneCastle launched its Federally Insured Cash Account (FICA) four years ago to address those fears. Through a network of more than 500 community banks, it enables institutions to invest up to $50 million in FDIC-insured accounts that are highly liquid, provide a stable NAV and relatively higher yield—features of traditional MMFs and then some.
Mr. Semilof said that between July 23 and late September FICA’s volume jumped more than 10 percent, and StoneCastle is seeing companies with larger cash balances expressing increased interest.
Jerome Schneider, a managing director and head of the short-term and funding desk at the Pacific Investment Management Co. (Pimco), said conversations leading to the launch of many of the bond giant’s MMF alternative products were sparked by institutional investors searching for higher returns. The prospect of MMF reform fueled even broader demand.
“Over the last 18 months or so, investors have been asking for products that offer higher yields and still allow them to be mindful of managing their liquidity and preserve capital,” Mr. Schneider said.
Mr. Schneider said Pimco has developed a plethora of short-term investment products because corporates’ investment needs vary widely, driven by factors including accounting and yield requirements. For example, Pimco’s Enhanced Short Maturity Exchange-Traded Fund (MINT) and Low Duration Exchange-Traded Fund (LDUR) are both short-term funds, with the latter launched in January to meet demand for a somewhat longer duration and higher yield.
“A company may have a lot of cash that they’re they’ll need soon, so if they can project their cash needs out a bit, we can provide more efficient ways to put their cash to work for them,” Mr. Schneider said.
Mr. Schneider added that Pimco’s Short Asset Investment Fund caters to institutions seeking very low volatility—approaching a fixed NAV. Its NAV has been flat or up 95 percent of the time, and it yields 50 basis points, providing a total return of 75 basis points by the end of September. Depending on their operational capacity, he said, institutions can instead choose other short-term products including mutual funds and separately managed accounts (SMAs).
SMAs give advisors the authority to access an account and trade its assets, and while they’ve typically been associated with investing in longer duration, higher risk assets, that needn’t be the case, Mr. Pan said. He added Capital Advisors is currently gauging clients’ receptivity to SMAs holding securities with maturities of 60 days or less, and various funds are exploring those waters as well. Under Rule 2a-7, such short-term MMFs can use the amortized cost method to arrive at their NAVs, instead of market values, making it easier to maintain a stable NAV.
Another short-term investment that institutions could pursue on their own or with the aid of SMAs is repurchase agreements, which are fully collateralized with typically high quality securities and can range in maturity from overnight, to a week, or longer. MMFs have been big repo lenders, but their bylaws typically require them to engage in very short-term transactions. Corporates have no such restrictions.
“They’re providing liquidity that money market funds can’t, and so that would provide them with a bit more yield,” Mr. Pan said.