Money Market Funds at Inflection Point
Declines in Prime Fund Assets and Opportunities for Investors
- An Industry at an Inflection Point – Outflows from prime funds have been more severe than forecast. Fewer funds and fewer fund companies are left in the prime space. While stable NAV government funds will likely continue to flourish, the appeal of prime funds has diminished.
- Diminished Yield Potential – The anticipated higher prime-to- government fund yield spread has not materialized, largely due to portfolio managers’ defensive measures.
- Immediate Rebound in Prime Assets Unlikely – The constraining WAM/WAL and liquidity requirements are formidable and permanent impediments. Shareholder uncertainty, presidential politics, Fed interest rate policy changes and year-end calendar effects all make an immediate rebound in prime assets unlikely.
- Market Dislocation Creates Opportunities – Reform-related fund flows resulted in lower demand for corporate paper and led to higher yield potential. Data suggests that a portfolio of AA-rated 90-day commercial paper may provide 3.0x and 4.5x the yield potential of institutional prime and government funds, respectively.
- Direct Purchases and SMAs – Taking advantage of the yield opportunities requires a mandate of direct purchases or a separately managed account (SMA). Structural changes to prime funds and recent investor surveys point to renewed interest in these mandates.
- Renewed Vigor in Counterparty Risk Accountability – An integrated risk tool may help steer investors in this direction in developing internal trading capabilities or gaining better insight into external managers’ credit performance.
The wait will soon be over! The future for money market funds was in doubt almost immediately after shareholders in the Reserve Prime Fund took principal losses eight years ago. Over this period, investors, issuers, asset managers, regulators, politicians, academics and interest groups had their say before the Securities and Exchange Commission (SEC) ordered two rounds of rule changes for the popular cash investment vehicle.