Grow or Die?
Confession: This eye-catching title is not our invention. It is borrowed from a panel discussion on money market fund distribution strategies held at the Crane Data Money Fund Symposium in Providence, RI in late August. We, however, think it brings out a salient point – growth for growth’s sake can be a recipe for disaster. The truism manifested itself when unsustainable growth strategies at certain leading fund companies contributed to the irrational investor behaviors that ultimately resulted in runs on money funds after the Reserve Primary broke the dollar last fall.
On the anniversary of the spectacular events of September 2008, the future of money funds undoubtedly dominates boardroom discussions at many fund companies, especially with the revised SEC 2a-7 regulations on money funds hanging in the balance. We wanted to take this opportunity to reflect on the presentations at the money fund symposium, hosted by Crane Data on August 23rd – 25th, that may influence whether the industry will grow, die, or end up somewhere in between. In the end, we believe it will take a sensible approach and a concerted effort from fund companies, regulators and institutional investors to preserve the sanctity, and ensure the survival, of a product treasured by many.
Past, Present & Future – You Are What You Invest
The portfolio managers’ panel discussion caught our attention in tracing the genesis of money funds. One manager reviewed the industry’s 40 years of history by the types of investments money funds bought. In the 1970s, fund portfolios consisted primarily of bank deposits and bank notes (94%). At this stage, the funds were lenders to banks, which then lent to business and individuals.
Then the 1980s ushered in innovations such as commercial paper and variable rate products. With commercial paper, which made up 30% of the portfolios, money funds allowed banks to help their most creditworthy business customers to borrow directly in the capital markets. The variable rate debt, which comprised of 15% of money fund portfolios, allowed issuers to pay short-term interest rates on long-term debt. Asset-backed Commercial Paper (ABCP) also was invented in the 1980s, although its popularity didn’t rise until later.
The 1990s continued with more innovations in financial CP, ABCP and non-traditional repurchase agreements. Towards the end of the decade, issuance of CP debt from industrial firms dwindled. Overtaking it was financial institution CP debt, which eventually became indistinguishable from bank deposits as funding instruments. ABCP programs (15% of fund holdings) also morphed from short-term financing solutions for bank customers to becoming the banks’ own off-balance-sheet vehicles for an assortment of bank loans. Repurchase agreements (25%) backed by Treasury obligations traditionally provided overnight funding to broker-dealers. In the late 1990s, they also started to morph with mortgage and corporate loans as collateral and lending terms were extended to as long as a year.
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