The Investment Company Institute released its latest monthly statistics, "Trends in Mutual Fund Investing: August 2011," as well as its latest weekly "Money Market Mutual Fund" series. They also released their monthly subscribers-only "Month-End Portfolio Holdings of Taxable Money Market Funds statistics. Money fund assets rose by $13.21 billion to $2.634 trillion in the latest week (ended 9/29) after rising by $72.7 billion in August, and ICI's August composition statistics showed a shift from CDs into Treasury securities.
ICI's weekly money fund release says, "Total money market mutual fund assets increased by $13.21 billion to $2.634 trillion for the week ended Wednesday, September 28, the Investment Company Institute reported today. Taxable government funds increased by $16.67 billion, taxable non-government funds increased by $230 million, and tax-exempt funds decreased by $3.69 billion." (Month-to-date in September (through 9/29), Crane Data's Money Fund Intelligence Daily shows that assets have decreased by $5.1 billion.)
ICI continues, "Assets of retail money market funds decreased by $2.71 billion to $936.28 billion. Taxable government money market fund assets in the retail category increased by $1.10 billion to $194.90 billion, taxable non-government money market fund assets decreased by $2.00 billion to $550.09 billion, and tax-exempt fund assets decreased by $1.82 billion to $191.29 billion. Assets of institutional money market funds increased by $15.92 billion to $1.698 trillion. Among institutional funds, taxable government money market fund assets increased by $15.57 billion to $686.55 billion, taxable non-government money market fund assets increased by $2.23 billion to $915.22 billion, and tax-exempt fund assets decreased by $1.87 billion to $96.34 billion."
ICI's monthly report says, "The combined assets of the nation's mutual funds decreased by $398.0 billion, or 3.3 percent, to $11.621 trillion in August, according to the Investment Company Institute's official survey of the mutual fund industry. In the survey, mutual fund companies report actual assets, sales, and redemptions to ICI. Money market funds had an inflow of $71.76 billion in August, compared with an outflow of $118.90 billion in July. Funds offered primarily to institutions had an inflow of $50.18 billion. Funds offered primarily to individuals had an inflow of $21.58 billion."
The statistics show total money fund assets at $2.641 trillion as of August 31, which represents 22.7% of all mutual fund assets. ICI's "Net New Cash Flow" figures show money fund assets with an inflow of $71.8 billion in August vs. an outflow of $118.9 billion in July. ICI's flows show outflows of $172.4 billion YTD 2011 vs. an outflow of $496.4 billion YTD in 2010 through August. ICI's survey tracks 433 taxable and 209 tax-free money funds (642 total) vs. 449 taxable and 219 tax-free money funds a year earlier (668 total).
ICI's separate "Month-End Portfolio Holdings of Taxable Money Market Funds" shows that Certificates of Deposits continued to decline in August (down $29.7 billion, or 5.6%), dropping them to the second largest money fund allocation spot with $498.4 billion, or 21.3%. (Eurodollar CDs, which we include in the above total, represent $96.1 billion, or 19.3% of all CDs, and they accounted for $9.1 billion of the drop in July.)
Repurchase Agreements (Repo), now the largest holdings of taxable money funds, increased by $44.3 billion to $511.3 billion, or 21.8%, and U.S. Government Agency Securities became the third-largest segment at 16.0% of holdings, or $376.0 billion <b:>`_, with an increase of $29.8 billion, or 8.6%, in August. Commercial Paper (CP) holdings, which fell to fourth place, increased by $15.5 billion, or 4.4%, to $368.2 billion. ICI showed Average Maturities shortening to 39 days in August and the number of accounts outstanding rose to 27.15 million.
Paul Schott Stevens, President and CEO of the Investment Company Institute spoke earlier this week in Luxembourg on "Sustaining Asset Management's Global Momentum" at the ALFI Global Distribution Conference. Stevens says, "Since 1992, worldwide mutual fund assets have risen from roughly $3 trillion to about $25 trillion, an eight-fold increase.... This remarkable rise was not preordained. It came, as the American statesman Dean Acheson observed, the way the future always does: "one day at a time." We have a record of which to be proud, no doubt -- and a very sobering set of responsibilities. If the next 20 years are to be as successful, we must continue to keep faith with our investors -- one investor at a time, one day at a time." (Note too that today's WSJ has an article "Call by Fed for Money-Fund Curbs", which has some quotes from industry nemesis Boston Fed President Eric Rosengren.)
He continues, "As might be expected, the global rise of asset management brings rising challenges, both for us and our regulators -- and many of these challenges came to the fore during the most recent financial crisis. The crisis reminded us -- if we needed reminding -- that managing assets is not the same thing as managing results. Like all other participants in the financial markets, our funds are affected by events in the real economy, by events in financial markets, and by government policies. Funds and their investors were hit hard by the crisis. I do not mean to suggest that asset managers were at the center of the financial crisis. Funds, in particular, did not cause the crisis. Instead, the strong systems of regulation that govern registered investment companies in the United States and comparable funds in other jurisdictions withstood that storm and served investors well."
Stevens says funds must "frame expectations." He explains, "All the products we make available to investors, whether they pursue the simplest or most complex investment strategies, involve risks. And, as we learned once again in the recent financial crisis, those risks can come from unexpected quarters and have significant consequences. I believe our investors generally understand that investing brings risks -- and that the prospect of enhanced returns brings with it a need to assume greater risks and volatility. But some policymakers and commentators don't understand that tradeoff -- or don't think investors are capable of comprehending it on their own. We see this in calls for regulation that would limit investor choices or impose particular investing models."
He adds, "While we work to protect our investors' choices, we also must ensure that we help investors balance their perceptions about our products with market realities. To this end, as ever, investors need better understanding of our funds. They need clear and concise information about the funds they choose. More broadly, we face a societal challenge in all of our countries to educate our citizens as investors. That means, first of all, educating citizens on the need to invest -- making sure they understand the risks of failing to participate in our financial markets, just as they understand the risks those markets pose."
Stevens also says, "Our second challenge is to maintain a strong culture of innovation. To a very large extent, finding new ways to serve the needs of investors has been at the heart of our success. Money market funds, index funds, exchange-traded funds, lifecycle or target date funds, sector and hybrid funds -- these are all examples of innovations that have answered investors' needs and fueled the global growth of investment management. Unfortunately, the financial crisis has given financial innovation a bad name in some quarters. Some policymakers and academics have concluded that financial innovation is useless or dangerous. Former Federal Reserve Chairman Paul Volcker has said on several recent occasions that "the most important financial innovation that I have seen the past 20 years is the automatic teller machine. Yes -- he's serious when he says that."
He explains, "Now, it is probably no accident that innovation in the capital markets is under attack at this time. One result of the financial crisis is the ascendancy of banking regulators and the notion that prudential supervision is the only valid model for financial regulation.... There is, of course, more than a little irony in the ascendancy of banking regulators, given that the financial crisis was first and foremost a failure of the banking system -- the latest in a string of perennial banking crises that have occurred despite numerous global efforts to increase bank capital and reduce risk."
Stevens tells us, "Indeed, three years after the worst of the financial crisis, policymakers trying to deal with sovereign debt issues on Europe's periphery are still constrained by fears about the banking system's stability. As one analyst recently observed, problems in the banking sector truly have been at the very center of all the recent turmoil. And yet many authorities place an overriding priority on the need to address the risks of the "shadow banking system." Depending upon who's using it, this loosely defined term can sweep in many of the activities in the capital markets, including a good portion of what funds do. This is a matter for concern -- not merely for funds, but for the financial system and our economies generally."
He explains, "To begin with, the term "shadow banking" is inherently misleading. As the Federal Reserve Bank of New York said in a staff report, "the label 'shadow banking system' ... is an incorrect and perhaps pejorative name for such a large and important part of the financial system." Second, sticking this misleading label on capital market activities implies that these activities are "loosely regulated" or even unregulated. The Financial Stability Board's recent note on shadow banking, for example, implies that a bank-dominated financial system is inherently superior, with less systemic risk. The note provides no substantiated basis for this view."
Finally, Stevens comments, "Bank-style regulation is neither necessary nor workable for U.S. mutual funds and their counterparts in other jurisdictions. It would deny our economies the benefits of diverse, competing channels for credit and capital. And it would concentrate -- rather than reduce -- the sort of systemic risks that we saw throughout the banking system in many, many countries in the recent crisis. At ICI, we have addressed these issues in a comprehensive response to the FSB's note. I urge that the fund industry globally continue to defend its unique role within the financial services industry."
Fidelity Investments' features an article on "What to do with your cash in its latest "Viewpoints" market update. Subtitled, "To find income potential you may have to confront risk," the piece says, "For the past several years investors have had to contend with paltry yields on money market funds, CDs, and other cash equivalents. With interest rates so low, you may have wondered if you should just stuff your cash under a mattress. But while finding yield in the short-term market is challenging, it isn't impossible. You may be able to boost the income your cash allocation produces -- but the downside is that you have to take on greater risk."
Chris Sharpe, portfolio manager on Fidelity's asset allocation team, comments, "There are opportunities out there to get more yield from your short-term investments. But you have to understand the potential risks.... The decision comes down to your needs: the role this allocation plays in your overall portfolio, and what you hope to get out of it given your needs and time horizon."
Fidelity explains, "To determine whether it makes sense to accept greater risk in exchange for greater yield potential, consider the purpose for your cash investments. In some cases you may require absolute stability, but in others you may be willing to accept the possibility of minor principal declines in exchange for higher interest payments."
They explain about low yields, "The Federal Reserve in December 2008 cut the target federal funds rate -- a key benchmark for short-term interest rates -- to a record-low range between 0.00% and 0.25%. The Fed's goal was to help pull the U.S. economy out of a deep recession and financial crisis. Many experts expected that rates would rise back to more normal levels after the economy stabilized. But nearly three years later, high unemployment and a halting recovery have persuaded the Fed to keep this influential short-term rate at its historical low point."
They say, "The low federal funds rate has acted as an anchor on yields offered by short-term instruments such as CDs, deposit and savings accounts, money market funds, and other short-term bond funds.... Yields on Treasury bills with maturities of three months or shorter hover around 0.00%, and have even dipped into negative territory when nervous investors flock to the highest-quality securities."
Fidelity tells us, "Some shorter-term investment options offer significantly more yield than money funds and T-bills. They generally have either lower credit ratings or longer maturities than the securities that make up traditional cash holdings. Those characteristics make the securities more vulnerable to declines -- but you may be able to stomach minor downturns in your principal value, depending on the use you have in mind for your money. In general, most investors manage the risk level of their portfolios by making decisions about the equity allocation or fixed income allocation. But to a lesser extent, you can make these same choices within the short-term portion of your portfolio."
Finally, Fidelity's Viewpoints says, "When deciding how to invest your cash, make liquidity -- how quickly you need access to the money -- a central consideration. In general, the more comfortable you are with risk and the less liquidity you need, the more yield you can afford to pursue.... Even in low rate environments, there are ways to increase the returns on short-term investments. But with investing, there is no free lunch. More yield generally requires assuming more risk. The key: make sure your choices match up with your goals, and your personal tolerance for risk."
Federated Investors posted two updates on current events in the money fund market -- one entitled, "European banks and Federated's prime money market funds," and the other named, "Federated's money market funds not affected by Moody's downgrades." The European update, written by Federated's CIO for Taxable Money Markets and Senior Portfolio Manager Deborah Cunningham, says, "As the European sovereign-debt crisis continues to remain in the headlines, it's important to separate actual risk from headline risk. The daily, stringent analysis that is at the root of how Federated operates its money market funds leads us to believe that there's still value in select European senior bank debt since the banks continue to represent minimal credit risk."
Federated also says that their funds were not impacted by Moody's recent bank downgrades. They say, "On Sept. 21, 2011, Moody's downgraded the long-term ratings for two U.S. banks -- Bank of America and Wells Fargo -- and their related bank holding companies -- and also downgraded the short-term ratings one notch for the bank-holding companies of Citigroup and Bank of America. Moody's reiterated that the ratings changes were not a reflection of weakened credit fundamentals at the banks or the bank-holding companies. Instead, Moody's explained that the ratings changes were a reflection of the company's opinion that there is decreased probability that the U.S. government would step in to support a large, systemically important financial institution if such help was needed."
They continue, "While Federated's prime money market funds own securities, primarily collateralized loan agreements, issued by the downgraded bank holding companies, there was no impact to the ratings of Federated's prime money market funds. Additionally, no Federated portfolio was required to make adjustments to its holdings as a result of these downgrades. Federated's experienced investment team continues to view these banks and bank-holding companies as representing minimal credit risk. The banks remain in Federated's approved database as issuers from whom the funds can purchase securities."
She writes, "Finally, it is important to remember that there is an additional level of U.S. regulatory scrutiny that applies to the European securities used in Federated money market funds . All of the European banks approved for use in Federated portfolios are globally diversified with operations in the U.S. Because the senior bank debt from these banks can be issued through their U.S. entities, these banks are subject to U.S. regulatory authority and oversight in addition to the regulatory standards mandated in their home countries. While it doesn't appear that the EU's debt woes will resolve themselves anytime soon, the extensive and daily credit work performed by Federated's portfolio managers and analysts, combined with the oversight of U.S. regulators, underscore our confidence that use of these carefully selected securities from major global European banks should continue to benefit our funds. "
The piece explains, "Federated's team of analysts and portfolio managers makes daily evaluations about each European bank that we own. The approved banks for our prime money market funds include 16 European banks from eight countries, each of which undergoes our stringent credit-analysis process just to make it on the list. We review capital structure, liquidity structure, management structure and other key factors, and are confident that the banks that make the cut are the best capitalized, most diversified, most liquid and highest quality names in the market."
It continues, "On average, 40% to 45% of the assets in most Federated prime funds are in securities from large, essentially global banks that are domiciled in Europe. These holdings have not changed significantly over the last month and offer relative value in the marketplace. Among the French banks, which have been much in the news over the last week or so, we have shortened maturities for new purchases. While Moody's recently downgraded the long-term debt of two French banks -- Societe Generale and Credit Agricole (the latter also remains on credit watch for a potential further downgrade) -- the ratings agency affirmed the banking companies' short-term ratings, which is the segment of the market with which we deal. Moody's also affirmed the short-term rating on BNP Paribas while leaving the long-term debt on credit watch."
Cunningham adds, "The exposure that European banks on our approved list have in the most troubled euro-zone countries is relatively minimal.... We've also determined that a potential default by Greece on its debt would be an earnings event for the banks, not a solvency event. This reflects the fact that the global banks in which Federated invests -- eight of the world's 10 largest banks are domiciled outside the U.S. -- have operations that reach around the world, potentially enhancing their ability to withstand events in any single country."
Last week was another busy one in the money markets, as Moody's downgraded some of the short-term debt of Citi and BofA, the Federal Reserve declined to reduce its IOER rate but announced "Operation Twist," and of course Europe continued to be an area of concern. On Wednesday, Moody's Investors Service downgraded Bank of America Corp. to P-2 (but left subsidiary Bank of America N.A. at P-1) and downgraded Citigroup to P-2 (but left Citibank at Prime-1). While these two banks are among the largest issuers and dealers in the money markets, J.P. Morgan Securities writes, "The impact of US banks' downgrades on money funds should be fairly minimal. This is because money fund exposure to US banks is only 15% of their total bank portfolio."
JPM's weekly "Short-Term Fixed Income" explains, "[T]he impact from a 2a-7 perspective is ... quite small, as technically they are still considered Tier 1 and not Tier 2 issuers. This is because they continue to hold '1' ratings from both S&P and Fitch (A-1/P-2/F-1).... [W]e think there may be some impact to Moody's rated money funds (both prime and government), which represent slightly over half of the money fund market. While Moody's new money fund methodology utilizes a more "holistic" approach ... we think the downgrade of BAC and C to P-2 could impact the funds from a repo perspective.... [O]ur best interpretation of the above is that funds could be limited to only O/N GC repo investment with P-2 rated counterparties, although they may continue to use the look through treatment under Rule 2a-7. However, as of August month-end, we estimate there were only $15bn of non-traditional repo and $1bn of term government repo between BAC and C."
In other news, on Friday, Fitch Ratings echoed other recent evidence indicating that money funds continue to gradually reduce their exposure to European holdings, particularly French banks. In a release entitled, "U.S. Money Fund Exposure to European Banks Declines Further," Fitch says, "European bank exposure [as of 8/31/11] currently represents 42.1% of total MMF holdings within Fitch's sample, down from 47.2% as of month-end July. [Note that unlike Crane Data, Fitch counts Treasury and Government-backed repo in their totals.] On a dollar basis, MMF exposure to European banks declined by 8% since month-end July and by 27% since month-end May."
Fitch's Robert Grossman comments, "Declining exposure to core European banks is being significantly offset by increasing investment in Australian, Canadian, Japanese and Nordic bank instruments." The release adds, "Fitch's analysis also found that the maturity profile of MMF CD exposures to European banks declined in some countries. As of month-end August, approximately 28% of MMF exposure to French bank CDs was in the shortest maturity bucket of seven days or fewer, a four-fold increase in this bucket relative to month-end June. Fitch based its sample on the 10 largest U.S. prime MMFs with total exposure of $676 billion as of Aug. 31, 2011. This figure represents approximately 45% of the $1.49 trillion in total U.S. prime MMF assets."
Finally, The Wall Street Journal has positive news for once in its "Fed's 'Twist' May Help Money-Market Funds". It says, "Money-market funds, often regarded as among the safest global investment vehicles, could soon get some much-needed relief thanks to the Federal Reserve's latest stimulus plan.... The Fed's new accommodation effort, dubbed "Operation Twist," may lead to better results. The central bank's plan involves selling shorter-dated Treasurys over the next nine months, a move that is designed to push short-term debt prices lower and force yields, which move inversely to prices, higher. Because money-market funds rely so heavily on short-term Treasury yields to generate returns, a boost of even one or two hundredths of a percentage point is a boon to managers who have been accepting bare-minimum interest all summer."
Below, we excerpt the second half of our latest Money Fund Intelligence "Profile," which interviews Waddell & Reed Portfolio Manager Mira Stevovich and Assistant Portfolio Manager Sabrina Saxer. MFI: Does being retail funds give you a more diversified and stable base? Stevovich: Yes, the flows are more predictable. Our shareholder base is very large. We have what I call 'sticky assets', in that if rates go down, investors don't necessarily leave the funds. Their concern is stability of principal and return of assets rather than a primary focus on return on assets. So there's not a lot of volatility in our flows.
Saxer: In addition to having a broad shareholder base, our average account size is quite small such that it would require an unusually large amount of transactions to materially impact our funds. We didn't experience significant redemptions during the crisis of '08 and in fact, on the whole received net inflows. The recent market concerns, including the credit downgrade of the United States and the European market disruptions, have not caused flow problems for us either. I believe this is true for most retail funds.
I think it is important to note that the industry has functioned incredibly well prior to and since the fall of 2008. During the several weeks surrounding this last crisis, money market funds, as a whole, experienced massive redemptions which did not disrupt the market from a liquidity standpoint. This should be a good measure for the regulators in their consideration of further changes to 2a-7 funds.
Stevovich: Retail funds, for the most part, were not impacted with regard to outflows to the same extent as institutional funds. I think that's what has been most difficult for us to accept, this 'one size fits all' regulation. Our funds are very different as the recent flow volatility shows, and the liquidity requirements are probably a little bit of overkill for the retail funds.
MFI: What about fee waivers and survivability? Stevovich: I believe for the foreseeable future that our management will continue to support the money funds as a service to our fund complex clients. Saxer: Currently, the 2a-7 funds provide a convenience for our customers. For now, subsidizing the money funds is part of our cost of doing business in this low rate environment. Rates can't stay low forever and in the future, this will be a profitable asset class again.
MFI: What are your thoughts on the future of money funds? Saxer: What I don't want to see is, as Mira pointed out, a 'one size fits all' regulation if we are to have more of it. We are not operating in a status quo environment as some in the media have put it. The SEC's amendment to 2a-7 last year made tremendous changes and enhancements to the rule. While I agree that many of the changes were important, some were very punitive for retail funds, in particular the creation of the 10% and 30% liquidity buckets. There should have been some sort of tiering based on the size and nature of the fund investor base. If you look at our flows during the most tumultuous times, you'd see that we had more than enough liquidity and 10% overnight is overkill. I would like to see the President’s Working Group proposals tabled for now.
Stevovich: I think a floating NAV for a retail fund would not be a wise move. I believe that would be contrary to why retail investors place their cash in a money market fund. I don't know which would be better, having some sort of liquidity facility or a capital reserve. If I had to choose one of the President's Working Group proposals, the NAV buffer is most appealing, mainly from the standpoint that it would be easiest for a retail fund to implement. Some of the other suggestions, I think would be too complex for a small fund to administer. Whatever additional regulation is mandated, I believe money market funds will continue on as an investment vehicle, because they fill a need for investors.
Saxer: The regulation that has been put into place has addressed what the main problem was back in 2008, and that was a liquidity issue. At this point, I think the additional changes are not necessary and would be regulation for regulation's sake. The Fed providing liquidity in 2008 was systemically important for all the markets at the time, not the money funds specifically. If you think about who actually benefitted from the temporary liquidity and other programs, it was everybody, including taxpayers. The entire market was not functioning. Money market funds have worked very well for a long time and are clearly systemically important for the health of our economy. I think that further regulation could have many unintended consequences and that well intentioned changes made to a $2.6 trillion industry could have very negative implications.
The Federal Reserve issued a Statement from the FOMC yesterday following its two-day meeting. They said, "Information received since the Federal Open Market Committee met in August indicates that economic growth remains slow. Recent indicators point to continuing weakness in overall labor market conditions, and the unemployment rate remains elevated.... Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee continues to expect some pickup in the pace of recovery over coming quarters but anticipates that the unemployment rate will decline only gradually toward levels that the Committee judges to be consistent with its dual mandate. Moreover, there are significant downside risks to the economic outlook, including strains in global financial markets."
The Fed continued, "To support a stronger economic recovery and to help ensure that inflation, over time, is at levels consistent with the dual mandate, the Committee decided today to extend the average maturity of its holdings of securities. The Committee intends to purchase, by the end of June 2012, $400 billion of Treasury securities with remaining maturities of 6 years to 30 years and to sell an equal amount of Treasury securities with remaining maturities of 3 years or less. This program should put downward pressure on longer-term interest rates and help make broader financial conditions more accommodative. The Committee will regularly review the size and composition of its securities holdings and is prepared to adjust those holdings as appropriate."
They added, "The Committee also decided to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that economic conditions -- including low rates of resource utilization and a subdued outlook for inflation over the medium run -- are likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013. The Committee discussed the range of policy tools available to promote a stronger economic recovery in a context of price stability. It will continue to assess the economic outlook in light of incoming information and is prepared to employ its tools as appropriate. Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Charles L. Evans; Sarah Bloom Raskin; Daniel K. Tarullo; and Janet L. Yellen. Voting against the action were Richard W. Fisher, Narayana Kocherlakota, and Charles I. Plosser, who did not support additional policy accommodation at this time."
In a separate posting, "Maturity Extension Program and Reinvestment Policy: Frequently Asked Questions," the Fed asked, "How is the program expected to affect short-term Treasury rates? Federal Reserve sales of short-term securities could put some upward pressure on their yields, but the effect is likely to be small. The Committee has stated that it anticipates that economic conditions will warrant the current level of the federal funds rate at least until mid-2013. This expectation should help anchor short-term rates near current levels, suggesting that shorter-term Treasury rates should not be significantly affected by the maturity extension program." (See also, Reuters' "Money funds look for yield boost from Fed action".)
The Federal Reserve Bank of New York posted a "Statement Regarding Maturity Extension Program and Agency Security Reinvestments," which said, "On September 21, 2011, the Federal Open Market Committee (FOMC) directed the Open Market Trading Desk (the Desk) at the Federal Reserve Bank of New York to purchase, by the end of June 2012, $400 billion in par value of Treasury securities with remaining maturities of 6 years to 30 years and to sell, over the same period, an equal par value of Treasury securities with remaining maturities of 3 years or less. The FOMC also directed the Desk to reinvest principal payments from its holdings of agency debt and agency mortgage-backed securities (MBS) in agency MBS."
Finally, the Fed did not announce any change in the payment of interest on excess reserves (IOER). (See our Crane Data Sept. 20 News "Money Markets Worry About IOER Cut; Fidelity's Brown Talks to Reuters", which quoted a WSJ.com article, "Some market participants expect the Fed, in its two-day policy meeting starting Tuesday, to try bolstering the economy by announcing a reduction or complete elimination of the interest it pays banks for storing excess cash at the central bank.") Money market participants had been concerned that this might push Treasury and repo yields into negative territory, so many were no doubt relieved that the Fed apparently didn't make this move.
In our latest Money Fund Intelligence "Profile," we interview Waddell & Reed Portfolio Manager Mira Stevovich and Assistant Portfolio Manager Sabrina Saxer. Waddell, founded in 1937, is one of the oldest mutual fund complexes in the United States. The advisor introduced its first money market fund in 1979, and the fund company now runs 79 mutual funds with $91.7 billion in assets (as of June 30, 2011). The first half of our Q&A follows. (Look for part two in coming days.)
MFI: How much cash do you run? Stevovich: We have three money market funds that currently total approximately $1.6 billion in assets. In addition, we manage the cash portion of our other mutual funds. Depending on the equity market, we have on average $3 to $5 billion in additional cash.
MFI: What's the biggest challenge in managing a money fund? Stevovich: Low rates for an extended period of time has been our biggest challenge. In addition, the weak economy has significantly decreased the supply of commercial paper available to us. Banks, which have historically been a big portion of the market, have been under tremendous pressure and have not been as attractive from a credit standpoint.
Saxer: I would have to add that I think that another big challenge has been and remains the regulatory environment. Stevovich: Yes, the regulation has been very challenging, however, on the positive side it has come at a time when we haven't had to focus on predicting the next Fed rate move. This has given us time to devote to implementing the new regulations.
MFI: Do you do more than manage the portfolio? Stevovich: Yes, in addition to managing the cash, we do our own internal credit work and due diligence. We have also been actively involved in building the new 2a-7 compliance models and mechanisms. For example, Sabrina created and maintains our stress tests. Also, because of all the new regulations, recently we have been interfacing more with our legal, compliance, and accounting staff. Saxer: We are an efficiently staffed shop, so it is not uncommon for us to be involved in all aspects of running the funds.
MFI: What are the funds buying now? Stevovich: Historically, we have invested in a combination of corporate and bank credits. However, since the 2a-7 amendment, we have increased our use of taxable and tax exempt VRDNs because they fit the 7 day liquidity requirement. Traditionally, we have not invested in repos for the money market funds, and given the extremely low interest rate environment, we don't anticipate investing in this vehicle in the near future. Currently, we are not investing in Euro zone banks or traditional asset-backed securities.
Saxer: We do, however, invest in Straight-A Funding, which is a unique asset backed program in that it has an SEC exemption letter that allows funds to consider the program U.S. government guaranteed. Regarding the VRDNs, in addition to providing liquidity, they have put options that allow for pricing at par. This helps keep the fund's NAV stable.
Friday's WSJ.com featured an article entitled, "Money Markets Face Adverse Effects If Fed Cuts IOER, which wrote, "There are expectations across the market that a stimulus measure the Federal Reserve might announce next week will end up hurting investors in the very economy it's trying to revive. Some market participants expect the Fed, in its two-day policy meeting starting Tuesday, to try bolstering the economy by announcing a reduction or complete elimination of the interest it pays banks for storing excess cash at the central bank. Goldman Sachs said there's a 50% chance this will happen." (The Federal Reserve Board of Governors meets today and tomorrow.)
WSJ explains, "The goal is to push banks to start lending and get the economy flowing. But analysts say lowering the interest on excess reserves, or IOER, will end up adding pressure to already ultra-low investment yields, in turn hurting money-market funds that are struggling to generate returns. U.S. businesses and consumers' appetite to borrow still hasn't fully recovered since the 2008 financial crisis. That's left banks flush with cash, which they don't want these days. Not only will they earn less for their reserves if the Fed slashes the IOER, they'd also face higher fees for holding more deposits because of new FDIC guidelines."
The piece adds, "This will likely force investors into other safe, short-term investments to try scraping together some type of return. Cash would flood the money-market space, pushing yields down and compromising the already-paltry returns money-market funds make and their ability to pay the costs associated with running these funds. Some Federal Reserve officials have expressed concerns about this."
In other news, Reuters article "Rules clash could limit money fund rates: Fidelity," says, "Conflicting regulations could limit the rates that money market mutual funds pay investors, a senior Fidelity Investments executive said, reflecting some of the many forces weighing on the sector. Rules passed by the U.S. Securities and Exchange Commission in 2010 require funds operated by Fidelity and its rivals to own more short-term securities, said Robert Brown, president of Fidelity money fund operations, in a recent interview."
The article adds, "At the same time, international bank capital rules known as Basel III, still under development, would have banks rely more on long-term debt, which would reduce the supply of short-term instruments in which money funds invest. The result could be lower returns for money fund investors, Brown said, even once interest rates rise from their historic lows of late."
Reuters explains, "Lower rates will only add to the pressures on the $2.6 trillion money funds industry, which has grappled with yields close to zero for several years. Industry tracking site cranedata.com shows the highest-yielding money funds paying only around 15 basis points, for instance. Fidelity and other firms have waived millions of dollars of fees in response. Charles Schwab Corp waived $240 million in fees in the first six months of 2011 alone. Other industry specialists have also begun to voice concerns about the appeal of money funds."
The Household sector continues to be by far the largest owner of money market mutual fund shares with $1.092 trillion, or 41.4%, of all assets at the end of the 2nd quarter 2011, according to the Federal Reserve's latest "Flow of Funds Accounts" statistical release. Funding corporations, which includes Securities Lending cash, ranked second with $665 billion, or 25.2%, of the total $2.638 trillion held in money funds. Businesses (nonfinancial corporate) remained the third largest segment with $498 billion, or 18.9%. Sec lending and business holdings of money funds declined on a relative basis, while Households increased their share of the total in the quarter, according to the Fed's data.
The Fed's quarterly "L. 206 Money Market Mutual Fund Shares <b:>" table shows that overall money fund assets fell by $42 billion in the quarter and by $123 billion in the year through June 30, 2011. Other holders of money funds in the Fed's table showed relatively flat assets. Private pension funds held $96 billion, or 3.6% of all assets, State and local governments held $89 billion, or 3.4%, the Rest of the world category held $84 billion, or 3.2%, Nonfarm noncorporate businesses held $66 billion, or 2.5%, Property casualty insurance and Life insurance companies each held $26 billion, or 1.0%, and State and local government retirement held $16 billion, or 0.6%.
The Fed's Z.1 series also features a table "L.121 Money Market Mutual Funds" which shows that Time and Savings Deposits and Securities RPs remain the largest holdings of money funds with $462 billion (17.5%) and $458 billion (17.3%), respectively. Repo holdings increased by $18 billion, or 1.0%, in the quarter, while bank deposits fell by $8 billion. Open market paper (which we assume is commercial paper) was the third largest holding in money funds with $361 billion, or 13.7%, Agency and GSE backed securities was fourth with $359 billion, or 13.6%, Treasury securities were fifth with $342 billion, or 12.9%, and Municipal securities were sixth with $306 billion, or 11.6%. Corporate and foreign bonds ranked seventh among money fund holdings with $153 billion, or 5.8%, Foreign deposits ranked eighth with $112 billion, or $4.3%, Miscellaneous assets held $64 billion (2.4%) and Checkable deposits and currency held $21 billion (0.8%).
Treasury Strategies noted Friday in a press release, "The Federal Reserve today reported corporate cash balances grew to $2.05 trillion -- a 4.5% increase over last quarter -- representing a $648 billion increase since the first quarter of 2009.... Companies continue to see strong cash flow from operations. Many highly-rated companies are taking advantage of the current low-rate environment to issue debt. Additionally, companies are returning cash to shareholders or deploying it to improve business operations."
Partner Anthony Carfang notes, "Historically, corporations have not been comfortable holding so much cash. However, changes such as unlimited federal deposit insurance for noninterest bearing accounts are making treasurers much more comfortable holding onto large sums of cash -- particularly when placed in the U.S. banking system."
Yesterday, we wrote about the 3-year anniversary of the Lehman Brothers bankruptcy, and tomorrow we will write about the anniversary of Reserve Primary Fund "breaking the buck". Today, though, we excerpt from news from the day in between, Sept. 16. It appeared as if the default would still be business as usual for money funds as several advisors stepped in to purchase the troubled securities and support their funds. Our Sept. 16, 2008 "Crane Data News" story, "Lehman Support Actions Push Money Fund Bailouts to 20 Total," said, "We wrote yesterday about money funds' limited exposure to Lehman Brothers and about the support actions taken by investment advisors so far. Evergreen and Russell have disclosed support agreement for their funds, while some other funds have disclosed Lehman holdings and pledged to maintain their $1.00 NAVs. The vast majority of money funds appear to have no direct exposure to Lehman, though they're now answering questions on AIG, which was downgraded to A-2 but is still P-1 (short-term ratings), and WaMu."
Our 9/16/08 piece continued, "The latest crisis should bring Crane Data's tally of the number of advisors supporting their money funds over the past 13 months to 20. Besides Evergreen, money funds disclosing or showing holdings of Lehman in recent public filings include: Columbia Cash Reserves, which held $400 million, or 0.73% of its assets; Reserve Primary; and Russell Money Market Fund. All are expected to protect their funds from any threat to the $1.00 a share NAV should it become necessary.
We quoted Russell, "The RIC and RTC money market funds have exposure to Lehman Brothers notes. Russell has been actively monitoring the situation and is entering into support agreements with the money market funds in which Russell and our AAA-rated parent company, Northwestern Mutual, will support the value of Lehman credit held in the funds to ensure that the funds continue to maintain a stable net asset value. The direct exposure in the RIC Money Market Fund as of Friday, September 12 was $403 million; in the Russell Trust Company Short Term Investment Fund, it was $75 million.
Dow Jones covered the story in, "Wachovia To Bolster Evergreen Funds, More Support To Come." It wrote, "[S]everal money funds reported holdings in Lehman paper in their most recent filings.... One example is the Primary Fund managed by New York money manager The Reserve. As of May 31, the $64.85 billion Primary Fund had some $785 million in Lehman commercial paper and medium-term notes." It added, "The Reserve has historically protected the NAV of its money funds as needed."
In other news, a statement entitled, "ECB announces additional US dollar liquidity-providing operations over year-end," said yesterday, "The Governing Council of the European Central Bank (ECB) has decided, in coordination with the Federal Reserve, the Bank of England, the Bank of Japan and the Swiss National Bank, to conduct three US dollar liquidity-providing operations with a maturity of approximately three months covering the end of the year. These operations will be conducted in addition to the ongoing weekly seven-day operations announced on 10 May 2010.... These will all take the form of repurchase operations against eligible collateral and will be carried out as fixed rate tender procedures with full allotment." See the ECB, Bank of England, Bank of Japan or Swiss National Bank websites for more details. See also today's Wall Street Journal, which features "Central Banks Pour Dollars Into Europe".
Finally, "Moody's assigned its 'Aaa-mf' ratings to three Morgan Stanley Money Market Funds yesterday. The ratings agency says, "Moody's Investors Service has assigned Aaa-mf ratings to the following three money market funds (collectively, the "Funds") managed by Morgan Stanley Investment Management Inc.: Active Assets Money Trust $6.5 billion, Morgan Stanley U.S. Government Money Market Trust $1.75 billion, and Morgan Stanley Liquid Asset Fund Inc. $6.2 billion. The ratings reflect the strong credit quality, elevated levels of overnight and 7-day liquidity, above average resilience to Moody's net asset value (NAV) stresses, and well-diversified, retail-focused investor base. Moody's expects the funds' composition to moderate from their highly defensive positioning due to the current market environment, but remain conservatively structured relative to peers. Due to the heavy retail oriented investor base, sourced primarily through Morgan Stanley Smith Barney's Financial Advisors, we believe the Funds will likely experience lower levels of shareholder volatility relative to more institutionally oriented funds."
Three years ago today, the world changed, and not just for money market mutual funds. The bankruptcy of Lehman Brothers and the failure of the U.S. Government to save it will likely go down as the biggest single mistake since the Smoot Hawley Tariff triggered the Great Depression. Prior to Reserve Primary Fund "breaking the buck" later that fateful week in September 2008, though, it seemed like it would be just another day of money fund bailouts (which had become almost routine in late 2007 and early 2008). Below, we excerpt from Crane Data's Sept. 15, 2008, News story, "Evergreen Issues Statement Supporting Lehman Holdings in Funds", and we also provide a glimpse into our latest Money Fund Portfolio Holdings collection, which will be released later today.
Crane Data wrote Monday morning (9/15/08), "A number of money market mutual funds are in the process of issuing statements either saying that they have no exposure to Lehman Brothers, which was downgraded to 'Not Prime' from P-1 ('First Tier') earlier today, or saying that they are taking steps to support their funds (or that their holdings are not large enough to impact the $1.00 NAV). Evergreen Investments was the first to issue a statement today saying that they've taken action to support their money funds. Though Lehman CP and MTN holdings are not widespread in money funds, other announcements are expected to follow."
We continued, "Evergreen's web posting says, "Wachovia Corporation has entered into support agreements with Evergreen Money Market Fund, Evergreen Institutional Money Market Fund, and Evergreen Prime Cash Management Fund in which Wachovia will support the value of Lehman credit held in the Funds. These agreements are intended to ensure that the decline in the value of the Lehman debt will not result in a decrease in the net asset value of the Evergreen money market funds.... Recognizing that continued liquidity challenges in the marketplace and ongoing media speculation may create concern for investors, we want to reaffirm Evergreen's commitment to carefully monitoring the situation and to providing information regarding the investment strategies of the firm's money market funds."
Finally, our Crane Data piece added, "Companies issuing statements to shareholders saying that they have NO exposure to Lehman Brothers (some also cite no exposure to AIG and Washington Mutual) include: AIM, American Beacon, BlackRock, DB Advisors, Federated Investors, Morgan Stanley, UBS and Western Asset Management." `Little did we know at the time that Reserve would be unable to arrange for a letter of credit to support its Lehman holdings, and that the world of money market funds was about to change forever.
In other news, Crane Data is preparing to publish its August 31 Money Fund Portfolio Holdings. While we're still proofing, cleaning, and adding Issuer, Country and other "tagging" to the latest dataset, last night we took a preliminary look at the largest issuers and exposure to the giant French banks. We found that money funds continue to reduce their exposure to BNP, SG and CA, but that the holdings remain major and that the retreat continues to be gradual and measured. (Of course, we assume this has reduction continued and perhaps accelerated in September month-to-date. Nobody knows this yet though.)
The top 15 issuers to money market funds as of August 31 (excluding the U.S. Treasury and U.S. Government Agencies), with their total outstandings, monthly asset change (both in billions) and percent change in money fund debt outstanding were: Barclays Bank $118B (+$31B or 35.4%); Deutsche Bank AG $85B (+$10B or 12.7%); BNP Paribas $74B (-$12B or -13.5%); Societe Generale $43B (-$8B or -16.2%); RBS $42 (-$8 or -15.6%); JP Morgan $38B ($2B or 4.9%); Credit Suisse $38B (-$5 or -11.9%); UBS AG $37B (+$1B or 3.7%); Rabobank $36B (-$3 or -8.4%); Bank of Nova Scotia $36B (+$4 or 13.5%); Westpac Banking Corp. $35B (-$2B or -6.1%); Credit Agricole $35B (-$3B or -7.5%); RBC $35B (-$2B or -6.1%); Bank of America $32B (-$9B or -21.6%); and Citi $31B ($0B or -1.5%). Among the largest issuers, the biggest decreases were seen in ING Bank $23B (-$13B or -36.5%) and BNP Paribas $74B (-$12B or -13.5%), while the biggest increases were seen in Barclays Bank $118B (+$31B or 35.4%) and Deutsche Bank AG $85B (+$10B or 12.7%). Our totals include CP (all types), CDs, and "Other" securities. We exclude Treasury and Government agency-backed Repo, but include Other Repo in our counts.
The Investment Company Institute posted a new "Viewpoint" entitled, "Deja vu -- U.S. Money Market Funds and the Eurozone Debt Crisis," written by ICI Senior Economist Chris Plantier and ICI's Senior Director of Industry and Financial Analysis Sean Collins. The pair explain, "In June, we wrote about the indirect exposure that U.S. prime money market funds have to European sovereign debt, especially Greek debt, through their holdings of securities issued by European banks. At that time, we noted that these funds had no direct exposure to Greek sovereign debt, and that they were managing their indirect exposure by constantly examining the quality of their portfolio and the creditworthiness of investments. By July 1, we could report that U.S. prime money market funds had no direct exposure to Portuguese or Irish government or bank debt."
ICI continues, "Since then, U.S. prime market funds have continued their careful monitoring and risk management on their portfolios. They have reduced their direct exposure to issuers in Italy and Spain to virtually zero, and have shortened maturities for their holdings of core European banks. Overall, U.S. prime money market funds remain well positioned to respond to potential developments in Europe."
They say, "Any likely downgrades in the long-term credit rating of large French banks would not affect money market funds' ability to hold these banks' short-term securities. [Note: As expected, Moody's did downgrade the long-term ratings of Societe Generale and Credit Agricole slightly this morning, but they left BNP and the highest short-term 'P-1' ratings unchanged.] Under Securities and Exchange Commission regulations, money market funds are required to hold short-term, highly liquid, high quality securities, with the vast majority of their assets in 'First Tier' securities, those with the highest short-term rating. Moody's Investor Service or other credit rating agencies may well decide to lower the long-term ratings for large French banking groups by one or possibly two notches. However, even a two-notch downgrade would leave the banks' short-term paper in the First Tier, and would not change those securities' status as eligible investments for money market funds. (For more on eligible securities for money market fund investment, see our FAQs.)"
Plantier and Collins tell us, "Direct exposure to both public and private issuers in the European 'periphery' countries is virtually zero. Since June, U.S. money market funds have almost eliminated holdings of Italian and Spanish government and private debt, including bank securities. U.S. money market funds have reduced the maturity of their holdings in banks in Europe's 'core' (France, Germany, the United Kingdom, and other countries)."
They continue, "According to JP Morgan Securities, 60 percent of U.S. prime money market funds' holdings in French banks as of the end of August will mature in 30 days or less, compared to 28 percent of their holdings at the end of June. Shorter maturities provide flexibility and reduce the impact of any potential downgrades. According to Crane Data, at the end of July, 69 percent of money market funds' holdings in German banks and 67 percent of holdings in British banks were set to mature in 30 days or less."
ICI writes, "U.S. prime money market funds have increased their liquidity this summer. As the August 2 deadline for raising the U.S. debt ceiling approached, U.S. money market funds generally increased the share of their portfolios held in highly liquid securities (cash, Treasury and some other government securities, and other securities that mature or can be converted to cash within five business days).... This increased liquidity allows prime funds to meet any increased redemptions associated with policy or market uncertainty in the U.S. and Europe."
Finally, they say, "Prime money market funds remain well positioned to respond to potential developments in Europe. Money market fund managers have been carefully monitoring and managing their exposure to European debt risks. Also, the core European banks are large, profitable banks, and all have access to liquidity facilities from the European Central Bank."
Online money market mutual fund trading portal Institutional Cash Distributors (ICD) published a "white paper" yesterday entitled, "Money Market Fund Reform Option #9," which "contends that significant corrective reforms made to Rule 2a-7 by the U.S. Securities and Exchange Commission in 2010 are already in place and working." A press release argues, "[T]he synthesis of the new fund data made available from these 2010 reforms, combined with new industry exposure analytics applications, have resulted in a comprehensive, end-to-end MMF investing process that the market place is widely adopting. This is Option #9."
The release explains, "There is an ongoing and spirited debate about how to best reduce Money Market Funds' (MMF) susceptibility to systemic risk. The October 2010 President's Working Group (PWG) Money Market Fund Reform Options report provided ... eight [possible] reform options and summarize[d] the potential pros and cons of their implementation.... This ICD commentary contends that the significant corrective reforms made to Rule 2a-7 by the SEC in 2010 are already in place and working, and that these reforms have been proactively adopted by industry leaders."
ICD's paper states, "Money Market Fund Reform Option #9 makes best use of the 2010 SEC Rule 2a-7 fund holdings disclosures and minimum liquidity requirements amendments in innovating new MMF investment guidelines and exposure analytics applications. Further, this industry-adopted solution -- referred to collectively as Option #9 -- has reduced the critical risk management gaps that caused the run on MMFs in 2008."
They comment, "The notion that money market funds were the cause -- the ground zero of the financial crisis -- is to misunderstand the real causes and to misrepresent the role of corporate treasurers.... Their investment objectives are first and foremost preservation of capital, followed by liquidity, and then yield. Prior to 2008, investors, believing that all triple-A rated funds were equally safe in regards to preservation of capital and liquidity, focused more on yield. As the subprime mortgage backed securities were bundled into even bigger mortgage derivatives and the toxicity spread worldwide the credit ratings agencies continued to provide triple-A ratings to prime funds even as several fund managers took exceptional risks to increase their fund yields. Investors were blind to these foreboding exposures."
ICD continues, "On September 16, 2008, the day after Lehman Brothers Holdings Inc. filed for bankruptcy, the Reserve Primary Fund, "broke the buck" as the Net Asset Value for the fund dropped below the stable price of $1.00 per share. Investors, without the benefit of fund analytics to assess underlying exposures of their portfolio positions, were unable to quickly or reliably differentiate between funds and were forced to sell en masse out of all Prime MMFs. Since then, corporate treasuries have accepted the 2010 SEC Rule 2a-7 reforms and have adopted the resultant new MMF investment guidelines tools and exposure analytics applications. To add additional reform measures now, specifically any of the eight reform options under consideration by the PWG, would risk destabilizing the progress that has been made internally by the industry and would create the possibility of unintended consequences that may produce new systemic risks, or worse, diminish MMFs as a viable cash management financial product."
They argue, "The damage from a diminished Money Market industry would not be isolated solely to money market funds and their investors. Money market funds are also key providers of liquidity and credit in the short term funding market.... Should these investment vehicles no longer perform their important function in the marketplace, corporations, municipalities and the federal government would have to seek access to credit through alternate means, potentially raising the cost of borrowing throughout the global economy."
Finally, ICD writes, "Draconian reforms are not the answer nor is merely agreeing to the 2010 SEC Rule 2a-7 amendments a complete solution to the problem. What is needed is an approach that leverages these 2010 reforms with technical ingenuity, business process, and wide-spread adoption to establish a self policing set of best practices that can be applied across the entire industry. Option #9 is the comprehensive solution that enables the corporate investor to drive the marketplace to a state of enhanced security and reduced credit and liquidity risk."
On Friday evening, J.P. Morgan Securities' released an "Update on prime money fund holdings for August 2011," which says, "Prime money fund holdings for the month of August revealed a further reduction of exposure to Eurozone banks. Month over month, holdings of Eurozone bank paper across all credit instruments (e.g., CP, ABCP, repo, time deposits, notes, etc.) declined by $50bn to $316bn, a 14% drop since July and a 23% drop since June."
The report comments, "Interestingly, the reduction in Eurozone holdings this past month occurred despite stabilization in prime money fund balances. In August, prime money funds lost only $8bn in assets under management, compared to $62bn in July and $85bn in June, suggesting that this month's decline in Eurozone paper was more driven by credit than liquidity."
JPM continues, "Of all the Eurozone exposures, French banks took the biggest hit with French CP/CD holdings declining by $47bn. However, this was partially offset by small increases to ABCP ($4bn) and overnight time deposits ($6bn), likely reflecting investors' preference for slightly higher yields while still maintaining very short maturities. Indeed, the percentage of French holdings maturing in less than 30d continued to increase, jumping to 60% last month from 48% in July and 28% in June."
The "Short Duration Strategy" report, written by Alex Roever, Teresa Ho, and Chong Sin, also says, "Beyond the French, most other Eurozone and European countries saw declining balances as well with the banks in Netherlands and the UK experiencing a $17bn and $15bn decrease respectively. However, there appears to be some rotation into higher-quality banks within the European region (e.g., Belgium, Germany, and Norway), mostly in the form of time deposits. With respect to direct peripheral exposure, prime money funds no longer hold any paper to Spanish banks. We estimate that they hold less than $250mm to Italian banks as of August monthend and will let those securities mature this month."
It adds, "Bank maturities were shorter despite the moderation in outflows last month. Regardless of home country, bank holdings maturing in 1-30d increased (Exhibit 2). The one exception was Japan which saw their 1-30d bucket decrease 12% month over month. Their 31-180d bucket increased by the same amount."
JPM comments, "Overall, since 1Q11, Eurozone bank holdings have declined by $125bn, roughly in-line with the $121bn of cash that exited prime money funds. French banks were most affected, experiencing the largest dollar decline of $59bn over this time period ($220bn as of 3/11 and $161bn as of 8/11). They lost on average $12bn of credit from money funds per month since the end of March. The next largest declines reside with the German banks at $27bn ($98bn as of 3/11 and $72bn as of 8/11) and UK banks at $18bn ($171bn as of 3/11 and $154bn as of 8/11)."
They write, "With that said, while the decline in dollar funding to Eurozone banks is sizable, we note that the amount of funding provided by US money funds to those banks represent only a small percentage of their total liabilities. We estimate on average, among the top 20 European banks that money funds provide credit to, money funds comprise only slightly more than 2% of their total liabilities."
Finally, the study expains in a Note, "J.P. Morgan estimates of geographic exposure in prime money market funds are based on a sample of large funds including funds managed by Fidelity, BlackRock, JPMorgan, Vanguard, Federated, Dreyfus, Wells Fargo, Goldman Sachs, UBS, Schwab, SSgA, American Funds, BofA, First American, Northern, Prudential, RBC, Western Asset Management. Sample represents 80% of US prime money market fund market in terms of assets under management. Allocation percentages are calculated from the sample and then applied to the period's total prime fund assets under management." (Crane Data's comprehensive Money Fund Portfolio Holdings collection with info as of Aug. 31 will be published on Thursday, Sept. 15, so look for more commentary on holdings in coming days.)
Fitch Ratings' latest "U.S. Money Market Funds Sector Update" says, "U.S. prime money market funds (MMFs) increasingly invest in repurchase agreements (repos) collateralized by nongovernment securities. This development is attributable to three major factors: prolonged shortage of supply of MMF-eligible securities exacerbated by increasing aversion to European exposures, the scarcity of U.S. government securities available as repo collateral, and an ultra-low interest rate environment." The report also says that European exposures are manageable. (Look for more data on money funds' August 31 portfolio holdings next week; Crane will release its latest collection on Thursday.)
Fitch writes, "European sovereign-related concerns prompted U.S. prime MMFs to rein in their exposures to French and other Eurozone banks during June, focusing on systemically important entities rated 'F1+' and limiting the weighted average maturities of their portfolios." It adds, "As discussed in the Fitch commentary, "Fitch: MMF 'Core' European Exposures No Cause for Immediate Rating Concern" dated July 8, 2011, funds were focused on large, financially sound banks with international franchises. Many of the banks found in Fitch-rated MMF portfolios are systemically important entities that are deemed to be well-positioned to manage their own exposures to peripheral Europe."
The report also says, "Weak U.S. economic data coupled with unstable conditions surrounding Greece's debt crisis created an environment where market participants view further monetary easing as possible if conditions do not improve. As of June 30, 2011, the average seven-day yield on individual U.S. prime institutional MMFs reported by iMoneyNet was 0.04%, down 3 bps from the first quarter.... While the implementation of MMF reform in 2010 has already reduced the risk profile of U.S. MMFs, the structure of the industry and the degree of systemic risk it poses continue to be debated. The timing of the further reform remains uncertain, although the MMF industry expects the final regulatory proposal to emerge sometime in the fall of 2011."
Fitch explains, "Assets under management (AUM) of Fitch-rated U.S. MMFs increased to $560.4 billion in second-quarter 2011 from $488.2 in March 2011. This 15% increase in AUM was largely due to addition of 10 MMFs managed by SSgA Fund Management (State Street), Williams Capital Management, and Milestone Capital Management. The portfolio composition of Fitch-rated U.S. MMFs remained relatively stable during the quarter, despite investor concerns over European bank exposures."
Finally, the report says, "Fitch-rated U.S. prime MMFs allocated approximately 16% of their total assets to repos, while holdings of time deposits (TD) declined <b:>`_. U.S. prime MMFs have been increasingly investing in repos backed by nongovernment assets. Fitch attributes this trend to three major factors. First, investor concerns over the continued deterioration of European sovereign credits and shortage of domestic investment opportunities led MMF managers to increase their percentage of portfolios allocated to liquidity mainly through repo investments. Secondly, the scarcity of U.S. government securities available caused greater acceptance of nongovernment repos. Finally, the ultra-low interest rate environment coupled with volatile credit spreads provide only a marginal incentive for MMFs to invest longer." Fitch shows among its "Top Five Repo Counterparties in Fitch-Rated U.S. Taxable MMFs," (as of May 2011) Barclays Bank AA–/F1+ ($16.7B), Deutsche Bank AA–/F1+ ($12.2B), BNP Paribas AA–/F1+ ($10.9B), `Bank of America ML A+/F1+, RWN ($9.5B), and Royal Bank of Scotland AA–/F1+ ($6.8B).
The September issue of Crane Data's Money Fund Intelligence newsletter gets e-mailed to subscribers this morning along with our August 31 performance data, rankings and indexes. The latest publication includes the articles, "Assets Rebound in August, But Worries Remain," which discusses the rebound in assets in August; "Waddell & Reed's Stevovich & Saxer," our monthly fund "profile" and manager interview; and, "SEC Taking 'Deliberative Approach' on Reforms," which reviews the recent exchange between Mary Schapiro and a Congressional subcommittee over the floating NAV.
The lead article says, "After getting beaten up by Europe concerns in June and debt ceiling concerns in July, money market mutual funds had a surprisingly positive August, at least as far as asset flows were concerned. Money market mutual fund assets increased by $58.2 billion during the month, the largest increase since January 2009. Money funds recovered just over half of their $106.7 billion July decline when concerns over the U.S. Treasury defaulting caused large outflows from Treasury and Government funds."
The September issue also interview Waddell & Reed Portfolio Manager Mira Stevovich and Assistant Portfolio Manager Sabrina Saxer. It says, "Waddell, founded in 1937, is one of the oldest mutual fund complexes in the United States. The advisor introduced its first money market fund in 1979."
Finally, we write, "SEC Chairman Mary Schapiro wrote a letter last Friday responding to a recent House Subcommittee's questions over the SEC's continued discussion of the floating NAV as a possible regulatory change for money market mutual funds. Schapiro wrote to The Honorable Scott Garrett, Chairman of the Subcommittee on Capital Markets and Government Sponsored Enterprises in the U.S. House of Representatives, saying, "Thank you for your letter dated August 12, 2011, regarding the Commission's continuing review of the regulation of money market funds, including the Commission's consideration of whether to require money market funds to use "floating" net asset values."
Our monthly Money Fund Intelligence XLS, which contains a host of performance statistics on money funds, rankings and our Crane Indexes, will be uploaded to the website and e-mailed to clients shortly, and our Money Fund Wisdom database has been updated with August 31, 2011 data. Note that our August 31 Money Fund Portfolio Holdings data set will be available to subscribers next Thurday, Sept. 15.
BofA Global Capital's Nancy Jerez, Managing Director, Head of National Institutional Sales, recently wrote a white paper entitled, "Is Your Investment Policy Due for a Course Correction?," which is subtitled, "An Updated Investment Policy Can Help Treasury Professionals Navigate Today’s Difficult Markets." She says, "As a treasury professional, you may face tough challenges these days trying to protect principle, maintain liquidity and optimize the yields on your organization's balance sheet cash. While it's never been easy to achieve those disparate goals, it's particularly difficult now due to a perfect storm of low interest rates, shifting regulations and macroeconomic headwinds generated by the European sovereign debt crisis and tepid economic growth in the U.S."
Jerez explains, "In this environment, it is especially important that you maintain an updated investment policy, an indispensable tool for those tasked with managing balance sheet cash. A detailed investment policy serves several purposes: it codifies your organization's investment objectives; it defines key portfolio metrics, e.g., liquidity levels and credit quality; and it identifies the investments you may leverage to achieve your investment goals. Structured correctly, an investment policy helps ensure that your investment strategy accurately reflects your risk tolerance and liquidity requirements, while providing guidance to the professionals managing your cash portfolios. Perhaps most important, it can instill the all-important element of discipline in your investment program."
The "Perspectives on Liquidity" "white paper" continues, "Because each organization's investment policy will reflect its own liquidity needs and return objectives, each policy will be unique. That said, all investment policies should feature the following: A clear articulation of your organization's risk tolerance, liquidity requirements and return objectives; Allowable securities (and those to be avoided); Guidelines for the construction and management of your investment portfolios; and, Mechanisms to promote ongoing compliance with the policy. In short, a sound investment policy is central to the effective management of balance sheet cash because it requires that you clearly articulate your investment objectives and detail the means by which you'll seek to achieve them."
Jerez writes, "The first step in updating your investment policy is to inventory all of your organization's cash because an investment policy is most effective when it encompasses all cash holdings. This means the investment policy must account for all investment vehicles (bank deposits, money market funds, separate accounts, and portfolios managed in-house); the purpose of the cash (for daily operating expenses or reserves) and the location of the cash, e.g., home country or abroad.... Once all of your cash holdings have been accounted for, you need to determine your investment objectives. The cornerstone of any effective investment policy is the clear statement of your goals, because those goals drive -- or should drive -- the development and implementation of your investment strategy. Most organizations list principal preservation as their primary objective, with maintenance of liquidity and achieving attractive yields as secondary and tertiary goals."
She explains, "Whatever the nature and needs of your organization, your investment policy should define the amount of cash necessary to fund daily operations and how it should be invested. Daily operating cash typically is invested in deposits or money market funds because they offer daily liquidity. Your investment policy might stipulate that operating cash be invested only in these highly liquid vehicles. For more stable cash, meaning the cash you do not require access to on a daily basis, you might consider investing a portion of it in a separate account, which may be able to offer higher yields than those in money funds. If you include separate accounts in your investment program, your investment policy should clearly stipulate the types of investments you consider acceptable and those you deem inappropriate."
Jerez tells us, "A prominent feature of most investment policies is the allowable investments section, which simply defines the security types you'll permit in your cash portfolios. Allowable investments generally reflect the organization's unique investment objectives and risk tolerance. It may define allowable securities for portfolios managed internally and others for the cash managed by outside advisors. Once defined, your allowable investments must be regularly updated to account for new investment products and to reflect shifts in the market."
She explains, "When we talk about diversification in the context of an investment policy, we're talking about concentration limits for your cash portfolios -- both those managed internally and others overseen by outside managers. Your policy might spell out the maximum concentrations allowed per issuer and per security type as follows: No more than 5% of the portfolio to be invested in any one issuer; No more than 50% of the total portfolio to be invested in corporate notes and bonds; No more than 10% of the total portfolio to be invested in asset-backed securities; and, The policy also might stipulate that your organization's investment in a money market fund cannot account for more than 5% of the fund's total assets. While these diversification guidelines can help limit concentration in a particular sector or issue, rigorous concentration limits can sometimes lead to unintended consequences, such as too much inefficiently invested cash."
BofA Global's Jerez writes, "Liquidity is the lifeblood of an organization. Creating and/or regularly updating an investment policy can help you maximize liquidity by clearly articulating your investment objectives and the steps you'll take to achieve them. The policy establishes the guidelines that will determine the key portfolio characteristics that drive portfolio construction and performance. Put simply, a regularly updated investment policy positions you to achieve your investment goals by providing the clarity of purpose and discipline that are central to the success of any initiative."
Finally, she says, "Of course, the effectiveness of an investment policy depends on the quality of the information and analysis on which it's based. The policy must be thoughtfully structured to reflect your organization's needs and the market's evolving risks and opportunities. Unfortunately, today's volatile market environment and investors' sensitivity to risk can undermine efforts to craft a sound investment policy. Strong risk aversion may lead to unnecessarily conservative investment guidelines, for example. At the same time, the complexities of today's short-term debt markets -- and of specific investment products -- can result in less-than-optimal policy guidelines regarding allowable investments and diversification. Given these realities, it is vital that you accurately assess the expertise and resources your organization can bring to bear when structuring your policy. If you have any doubts about your ability to effectively evaluate and update your investment policy, your first and most important task should be to identify an investment firm with the expertise, the resources and the objectivity necessary to help you capture the many benefits a well-structured policy can deliver."
The most recent "Month in Cash" money market update from Federated Investors is entitled, "In search of value". In it Chief Investment Officer for the Taxable Money Markets, and Senior Portfolio Manager Deborah Cunningham writes, "Some cash yields ticked higher in August as sovereign-debt issues that had been festering on both sides of the Atlantic were resolved, at least temporarily. With investors feeling more confident that another global financial crisis was not imminent -- thus reducing the compulsion to horde cash -- one-month London interbank offered rates (Libor) Libor closed up 3 basis points at 0.22%, three-month Libor climbed 7.2 basis points to 0.33%, six-month Libor rose 5.6 basis points to 0.49%, and 12-month Libor increased by 4 basis points to 0.80%."
She continues, "Offsetting those increases, however, were sharp drops at the extreme short- and long-term ends of the cash-yield curve. As the month began, worries over funding stresses on some European banks had caused overnight rates to spike into the mid-teens; the resolution to Greece's debt drama subsequently pushed repo rates back down to the mid single-digits and Treasury bill yields to zero or below. The pattern was similar at the long end of the curve, with the yield on the Treasury's two-year note plunging to a record low of 0.19% in mid-August after the Federal Reserve pledged to keep benchmark interest rates at virtually zero for the next two years. Fed Chairman Ben Bernanke and other central bank officials subsequently tweaked the 'free money for longer' message to give policymakers more flexibility in the event that inflation revives or the somnolent U.S. economy perks up faster than many now expect."
Cunningham adds, "Not surprisingly, value in the cash market was in short supply. The unusually generous repo and Treasury bill rates that prevailed in early August were compelling while they lasted, but we made only modest forays out of the overnight market in search of longer-term yield pickups due to concerns over possible withdrawals. With investors fearing a reprise of the September 2008 banking crisis, we chose to maintain a high degree of liquidity to meet possible redemptions in the event of another global panic. We are pleased to report that no such rush for the exits occurred. A slight uptick in repo rates near the end of the month -- a reflection of renewed jitters over the viability of the latest Greek bailout package -- could present an attractive buying opportunity if the trend persists, given our view that most European banks are more than sufficiently capitalized."
Finally, Federated writes, "Though Fed Chairman Bernanke's presentation at the global economic symposium in Jackson Hole, Wyo., in late August was arguably the most widely anticipated speech in recent financial market history, Bernanke did not announce any additional monetary measures to bolster the faltering recovery. Instead, Bernanke made it clear that fiscal policy now must do its part to restore confidence. Notably, a schism has formed on the Fed's rate-setting committee, with at least three members dissenting from the promise to keep rates at current levels through mid-2013. At a minimum, we expect the Fed to continue reinvesting proceeds of maturing agency and Treasury debt." (Also, see a recent video interview with Debbie Cunningham in Federated's "Money Matters" section.)
Money market mutual fund assets increased slightly in the latest week, but this marked the 3rd week in 4 that funds have seen asset increases. Funds have now recovered over half of the outflows associated with the Treasury debt ceiling debate. In the 3 weeks ended August 3, money funds lost $114.3 billion in assets, but they've gained $68.7 billion over the past 4 weeks. Year-to-date, money market mutual fund assets have declined by $173 billion, or 6.2 percent. Institutional funds account for all of the decrease, declining by $173 billion, or 9.3%, while Retail money funds now show an increase of $1, or 0.1%, YTD through August 31.
The Investment Company Institute's latest "Money Market Mutual Fund Assets" report says, "Total money market mutual fund assets increased by $7.95 billion to $2.637 trillion for the week ended Wednesday, August 31.... Taxable government funds increased by $7.91 billion, taxable non-government funds increased by $1.37 billion, and tax-exempt funds decreased by $1.34 billion."
ICI explains, "Assets of retail money market funds increased by $33 million to $944.80 billion. Taxable government money market fund assets in the retail category increased by $1.65 billion to $193.01 billion, taxable non-government money market fund assets decreased by $527 million to $557.78 billion, and tax-exempt fund assets decreased by $1.09 billion to $194.01 billion." Retail assets now account for 35.8% of all money fund assets, up from 33.6% at the beginning of 2011.
They add, "Assets of institutional money market funds increased by $7.92 billion to $1.692 trillion. Among institutional funds, taxable government money market fund assets increased by $6.26 billion to $665.20 billion, taxable non-government money market fund assets increased by $1.90 billion to $926.11 billion, and tax-exempt fund assets decreased by $242 million to $100.89 billion."
Money fund assets declined by 14.0% ($537 billion) in 2009 and by 14.7% ($483 billion) in early 2010, following a $1.3 trillion increase from August 2007 through January 2009. Assets now stand at the same level they were during the first week of 2007, just prior to the start of the "Subprime Liquidity Crisis," $2.6 trillion.
Crane Data is estimating that money fund assets will flatten and drift slightly lower over the remainder of 2011 (assuming, of course, that the risks of a headline-induced European concern run are past). We have indicated to clients that we think money funds will end the year down 10% at the $2.53 trillion level, then will decline an additional 5.0% in 2012 to the $2.5 trillion level. We assume funds will then begin attracting assets again in 2013, as interest rates begin to slowly rise. Crane estimates that money funds will gain 5.0% in 2013 to $2.523 trillion, 10% in 2014 to $2.775 trillion, and 5% in 2015 (as rates plateau out around 3%) to $2.914 trillion.
SEC Chairman Mary Schapiro wrote a letter Friday responding to a House Subcommittee's questions over the SEC's continued discussion of the floating NAV as a possible regulatory change for money market mutual funds. (See Crane Data's August 17 News "House Subcommittee Cautions, Questions SEC's Shapiro on Floating NAV".) Schapiro writes to The Honorable Scott Garrett, Chairman of the Subcommittee on Capital Markets and Government Sponsored Enterprises in the U.S. House of Representatives, "Thank you for your letter dated August 12, 2011, regarding the Commission's continuing review of the regulation of money market funds, including the Commission's consideration of whether to require money market funds to use "floating" net asset values ("NAVs")."
She continues, "The severe problems experienced by money market funds in 2007 and 2008 prompted the Commission to review our regulation of money market funds and to adopt a number of reforms in 2010 intended to make money market funds more resilient in order to prevent another run by fund shareholders. The run on institutional money market funds in September 2008 was stopped only as a result of an unprecedented intervention into the short-term markets by the Department of the Treasury and Federal Reserve Board. When we adopted the 2010 money market reforms we noted that they were only a first step to addressing our concerns and that the Commission would continue to consider more fundamental changes to the structure of money market funds to prevent a future run, which could harm investors, and potentially damage or destabilize the short-term markets. Subsequently, a number of policy options were explored in detail in a report prepared by the President's Working Group on Financial Markets."
Schapiro writes, "The PWG Report identified the stable net asset value feature of money market funds as a characteristic that contributed to the susceptibility of money market funds to runs. It suggested requiring money market funds to operate with a floating NAV as one of several possible reforms that the Commission could consider. The Commission subsequently requested public comment on the recommendations set forth in the PWG Report and received a number of helpful suggestions, including additional options for reform. In addition, in May the Commission hosted a Financial Stability Oversight Council roundtable on money market funds and systemic risk. At that public roundtable, financial regulators, money market fund managers, investors, academics and others debated the merits of various reform options, including a floating NAV."
Finally, she tells the Subcommittee, "I want to assure you that the Commission is taking a deliberative approach and reviewing the potential advantages and disadvantages of various policy options including a floating NAV. We know that there are also substantial risks in failing to address the risks that came to light in the financial crisis and are identified in the PWG Report. We are committed to carefully exploring all of the options available to us before moving forward and will consider carefully all of the comments we receive. As always, I welcome the opportunity to share our views with you and your colleagues. I have asked the staff of the Division of Investment Management to prepare responses to your specific questions, which are attached to this letter."
The attached, "Responses from Staff in the Division of Investment Management related to Money Market Mutual Funds," states, "1. Do all investors understand that money market mutual funds pose some risks and are not insured deposits? If not, could the SEC enhance existing disclosures which explain money market mutual fund risks? 2. Do all investors know that a money market mutual fund's net asset value has the ability to fall below one dollar? Are there ways to increase transparency around a•fund's net asset value without floating the NAV? All money market funds are required to disclose that they are not insured or guaranteed by the FDIC or any other government agency and that, despite the funds' efforts to maintain a stable NAV, investors may lose money. The PWG Report states that, notwithstanding these disclosures, (i) investors have come to view money market funds as extremely safe, and in some cases as risk-free cash equivalents, in part because of the funds' stable NAVs and their sponsors' longstanding practice of supporting funds that might otherwise lose value, and (ii) the federal government's unprecedented support of money market funds in 2008 and 2009 may have left investors with the impression that the government stands ready to support money market funds again with the same tools employed at the height of the financial crisis."
The Responses continue, "3. Do all money market mutual funds pose the same risk to the U.S. financial system? Some money market funds likely pose more risks to the U.S. financial system than others. For example, a small institutional money market fund "broke the buck" -- that is, it was unable to maintain its stable NAV -- in 1994 without causing significant repercussions. In contrast, the Reserve Primary Fund's inability to maintain its stable NAV in September 2008 contributed to a run on institutional money market funds, which impaired access to credit in short-term private debt markets and prompted unprecedented market interventions by the federal government to stabilize and provide liquidity to these markets. It is difficult, however, to identify in advance which money market funds are likely to pose more risks than others. For example, notwithstanding the experience in 1994, a small fund's breaking the buck under financial conditions extant in 2008 could pose a serious risk to the U.S. financial system if it led to a broader run on money market funds."
They also ask, "6. What would happen to the long-term viability of money market mutual funds if the Commission required the net asset value to float? It is difficult to assess how a floating NAV would affect the long-term viability of money market funds. The PWG Report, however, does identify a number of potential concerns raised by a switch to a floating NAV, including that this change could reduce investor demand for money market funds and cause investors to shift assets to other vehicles or products, including to bank deposits or to stable NAV substitutes that may be subject to less regulation than money market funds. Investors' acceptance of floating rate money market funds likely would be based on a number of factors, including consideration of available substitutes and, in the case of institutional investors, the investment guidelines and operational constraints applicable to each investor."
The SEC's Division of Investment Management continues, "7. Would requiring money market mutual funds to float their net asset values have negative consequences on the ability of both the public and private sectors to meet their short-term funding needs? The PWG Report identifies the possibility that requiring money market funds to use a floating NAV could reduce investor demand for money market funds and thereby reduce the extent to which money market funds lend in the short-term markets. The PWG Report does note the possibility that a reduction in demand for money market funds could adversely affect the availability of some types of short-term credit which today are provided predominantly by money market funds. Whether this would negatively affect the public and private sectors' ability to meet their short-term funding needs would depend on the extent to which any investors' substitutes for money market funds engage in similar short-term lending."
They add, "8. What empirical evidence does the Commission have to support a floating net asset value for money market mutual funds? The Commission continues to gather empirical evidence relevant to all aspects of money market fund reform, including evidence related to the Commission's consideration of a floating NAV. For any policy option the Commission pursues, it would seek public comment on it and other options, and would carefully consider the empirical evidence it received together with the evidence independently identified by its staff."
Finally, the staff writes, "9. Could the Commission prevent future stress on money market mutual funds with enhanced oversight by using its authority to require a fund provider to de-leverage certain assets, or is the floating net asset value the Commission's only option to prevent a run on one or more funds? The Commission is considering a number of potential further money market fund reforms. A floating NAV is just one of the options under consideration. For example, the Commission recently sought public comment on a number of possible reforms identified in the PWG Report. These reforms include, in addition to a floating NAV, private emergency liquidity facilities, insurance for money market funds, the regulation of money market funds as special purpose banks, and other options. Commenters on this report also identified additional possible regulatory reforms, including various forms of capital buffers for money market funds. The Commission continues to consider the comments it has received on these and other possible reforms."