Institutional Prime Funds Are Down But Not Out
It’s been a year since new SEC rules restructured institutional prime money market funds by requiring that they float net asset values (NAVs) and impose redemption restrictions in times of fiscal stress. When the changes hit, a generation of cash managers who had always turned to prime funds as a matter of course suddenly were confronted with a new risk/reward equation that sent them scurrying for alternatives. The threat of restricted access and fluctuating valuations precipitated an $800 billion flight out of prime funds, with government funds picking up much of the slack. But the new rules didn’t kill off the old institutional prime funds. After the near-fatal blow to their popularity as essential cash management tools, they recaptured some lost ground and now seem to have found a stable footing. There’s even been a modest $26 billion increase in institutional prime fund holdings since the drop-off. But the reconfigured prime funds offer a new and different set of incentives than in the past.
This month’s Capital Advisors Group research report, First Annual Checkup on Reformed Institutional Prime Funds, takes their temperature and provides a useful guide to managers trying to understand the new risks and opportunities. Among other things, yield on prime funds benefitted from higher fed funds rates, maintaining a prime-over-government yield spread of more than 0.20 percent. That spread may not be enough to lure most cash investors back into prime funds, but interest appears to be building. And the SEC’s Rule 2a-7 governing the funds continues to offer better protection and safeguards to cautiously interested investors than ultra-short bond funds and private liquidity funds, which may be one reason institutional prime fund assets have started growing again after bottoming out last year. At the same time, the more specialized appeal of the new funds may limit their long-term growth potential relative to government funds. So many investors are adopting a two-tier structure of government and prime funds as the preferred route to improving liquidity and yield potential.
To manage risk as they strike the right balance of liquidity and yield, cash investors need to understand the new dynamics of institutional prime funds. This month’s research report provides insights that can help.