Nancy Prior, President of Fixed Income at Fidelity Investments was the keynote speaker yesterday at iMoneyNet's Money Market Expo (MMX) which took place in Orlando this week. (Note: Crane Data produces MMX's main competitor, our Money Fund Symposium, which will be held June 24-26 in Minneapolis.) Fidelity released the transcript of the speech, titled "Money Market Funds: The New Reality." In it she explains Fidelity's move from prime to government funds, the market and supply implications of that move, and how Fidelity will still be a major player in prime funds. Here are some excerpts. (Note also our new "Link of the Day" on Reich & Tang exiting the money fund business.)
Prior began, "Last year, the title of my speech was "Let's Get It Right" -- "it" being the impending, long-anticipated, but still unfinished money market fund (MMF) regulation. This year, we're here to focus on "The New Reality".... And I am here to talk specifically about the implications of the new SEC rules, and about how we -- all of us across the industry -- are responding now; how we need to proceed over the next couple of years; and how it may impact our shareholders and the markets."
She continued, "Let me talk a little bit about how Fidelity has chosen to move forward and what went into our decisions, as I appreciate the fact it has implications for the MMF segment as a whole.... Our first priority was to make sure that our product line meets the needs of all of our customers. We started by reviewing all the investor use cases for our money market funds. Like other firms, our use cases are many and varied. On the institutional side, we have corporate treasurers who invest balance sheet cash for later capital spending, and companies who use funds regularly to meet payroll or other operating expenses. Our clients also include state and local governments, as well as nonprofits that use MMFs as an alternative to banks.... Other types of institutional clients -- which may be eligible to invest in retail funds under the new rules -- are bank trust departments, broker-dealers and other omnibus providers who invest money for individuals in large single trades. On the retail side, our MMF investors include retirement savers in 401(k) plans and IRAs, asset allocators and customers saving for a major purchase or life event. At Fidelity, the largest block of retail money market fund investors are brokerage customers who use a money market fund as a core account. That core account is where all mutual fund and security purchases settle. It is also often used to write checks, make ATM withdrawals and pay bills."
Prior explained, "During the latter part of 2014, we solicited a lot of feedback -- via surveys, investor forums, and direct client outreach -- to help us figure out what our lineup should look like in order to meet the specific needs of each customer segment. Our retail core account customers made it clear that they did not want any possible interruption in their ability to make trades, write checks or pay bills. I remember well one gentleman, who participated in one of our many client conference calls, and who demanded to know whether Fidelity was going to "break his trade" under the new rules for prime funds. And we saw similar objections in the surveys."
She said, "For example, in this slide of one of our customer polls, 53% of respondents told us that the possibility of fees or gates on their core account would cause them to make a change in their holdings. And of that 53% who were very likely or somewhat likely to make a change, 73% indicated they would pull all or most of their money out of an affected fund and move it to another investment at Fidelity."
Prior continued, "So, even with the assurance of a stable NAV for these retail funds, the very remote possibility of fees and gates is not acceptable to a certain segment of our customers. We heard the same from workplace savings plan sponsors and investors. The challenges of mandatory distributions, hardship withdrawals and regular defined contribution plan processing make prime funds less attractive to many DC plans. Given this direct feedback, we were driven by the idea of keeping things as simple as possible for our customers."
Further, she explained, "So, after careful deliberation, we determined it was in our customers' best interest that we recommend changes to the Fidelity funds' Board of Trustees for two uses of MMFs: brokerage core accounts and workplace savings plans. As a result, last month, after Board approval, we announced a proposal to convert three of our retail prime MMFs that are used primarily in core accounts or retirement plans, including our Fidelity Cash Reserves fund, to government MMFs. Assets from the three funds total about $130 billion."
Prior continued, "The Cash Reserves fund itself is about $110 billion of that total. As part of this rationalization of our lineup, we are also planning to merge several funds that have similar investment strategies. These mergers are intended to simplify and streamline Fidelity's MMF offering and make it easier for investors to choose a fund or class that best meets their needs. Importantly, though -- and I want to really emphasize this -- we will continue to offer a full suite of MMFs: Retail and Institutional Prime and Municipal funds, along with government and Treasury funds."
Prior commented, "Using iMoneyNet data as of year-end 2014, Fidelity's MMF asset mix is 62% prime, 21% government and 17% muni, with total assets of $420 billion.... If the three proposed conversions are approved, the composition of our assets would shift to be 31% prime, 17% muni and 52% government.... You can see that even when these conversions take place, we will likely remain among the top five prime MMF firms, with well over $100 billion in prime assets. So -- bottom line -- we will remain a major player in the prime market. We realize that these changes have implications for both our customers and the industry at large -- especially if other MMF advisors choose to follow a similar path, as it appears some will. We are confident, however, that our approach is sound and sustainable, and the right one for our shareholders."
Prior added, "Let's look at some of the market implications, and how they may play out. First, let's discuss the implications for the industry on available supply of government securities in the money markets. This slide, which cites data from J.P. Morgan, compares the available supply in government and prime securities with the assets of MMFs in those categories. What stands out immediately is how large the supply bar is when compared to government MMF assets. You can see that the total supply of MMF eligible government securities stood at $6.6T at the end of 2014. Obviously, there is demand for government securities from sources other than government and Treasury money market funds."
She said, "However, the government securities market is enormous, at close to $7T. So each $100B in incremental demand represents just 1.5% of the available supply. While we do not know other firms' plans, let's just use Moody's estimate of an additional $100-$200 billion of assets' converting to government from prime, which may end up being high. Taking the middle of that range -- $150 billion -- and adding that to Fidelity's proposed conversions gets Moody's total estimate to $280 billion. That additional $280 billion in demand represents only about 4% of the total supply of government securities. So, standing where we stand right now, we believe that the converted MMF assets within the industry will have no trouble finding investments in the government market.... There continues to be adequate supply for prime MMFs, but we are seeing a trend of regulatory changes causing financial institutions to issue less short-term paper."
She continued, "As we know, investors in MMFs have historically had three goals: NAV stability, ready liquidity and market yield. Like many other firms, we at Fidelity have managed our MMFs with those priorities, in that order, for decades. The new rules make it challenging to deliver on all three going forward. Government funds are able to pursue the first two goals of NAV stability and ready liquidity, but there may be a trade-off for customers in the form of slightly lower investment returns via government, as opposed to prime, MMFs. This is something that investors will need to be informed of and understand. It's an open question, however, how significant that trade-off will be, and how it will influence investors' decisions."
Prior commented, "Of course, the planned transition of assets from prime funds to government funds will have an impact on yields, and the yield spread between government securities and prime securities such as commercial paper and CDs is likely to widen. But quantifying just how much is difficult, not only because we don't know how big the shift will be, but also because there are dynamics in the supply for prime securities that will continue to put downward pressure on their supply, which will, in turn, pressure yields lower."
She told the Orlando audience, "Now, I would be remiss if I did not talk today about the many reasons for optimism in the MMF industry going forward. Because, at long last, the climate in which we will be implementing these changes appears to be an improving one. The final SEC MMF regulations are now known, and we are all in the process of adopting them. Meanwhile, the extraordinarily difficult interest-rate environment we've endured for seven years appears, finally, to be improving -- though it is fair to say I state that with "cautious optimism." At any rate, for the first time in a long time, we can see daylight for our industry and for MMF investors."
Finally, Prior concluded, "As we proceed into 2016, we will focus on some of the other changes we're required to make -- adopting the fees and gates requirement for all prime and municipal MMFs, and the floating NAV for institutional prime and muni funds. Right now, we are hard at work, setting ourselves up to comply with the new rules. As we continue to get our houses in order -- seeking approvals from fund boards and shareholders -- we will put our product lineups in the right place to begin implementing the structural changes. It will be a massive effort for all of us, and it's just ramping up. The near- and long-term future will not be without continued challenges, but I believe we have the potential to emerge stronger, and certainly more resilient, than ever. Our true north remains our mutual commitment to ensuring the safety, stability and viability of the money market product for our customers."
