BlackRock. published a brief titled, "Why money market funds play a vital role in private markets," which tells us, "Research shows that the total value of private-market assets -- including debt and equity investments in private businesses as well as infrastructure and real-estate holdings -- is on course to rise from US$10 trillion in 2021 to more than US$18 trillion by 2027. In 2024, meanwhile, there was a sharp rise in distributions from private equity investments, along with a rebound in deal-making and exit activity. It is clear this is a sector that has recently experienced solid growth, and we expect this sector to continue at pace over the next few years as the market is increasingly democratized to an ever-wider investor base."
The article, targeted to "offshore" institutional investors, continues, "The significant inflation that emerged after the pandemic, further intensified by rising geopolitical tensions, prompted central banks in Europe and North America to swiftly raise interest rates in 2022 and 2023. This has transformed cash into an important asset class once again after years of very low, or even negative, returns."
It says, "For firms in private markets, a higher-rate environment is not just an issue in terms of raising capital or discounting long- term investment returns. There is also an important operational element related to the cost of holding cash -- whether this is in the form of money awaiting distribution to limited partners (LPs), capital calls from investors or management carry."
BlackRock tells us, "At the same time, the last few years have been synonymous with periods of heightened volatility and market risk. Events such as the 2023 collapse of Silicon Valley Bank and subsequent concerns regarding the creditworthiness of some European banks, combined with geopolitical and macroeconomic uncertainty, have led many institutions, including those within the private markets space, to re-evaluate how and where they are holding cash. The importance of diversification and avoiding the cash concentration risk that comes when holding cash on balance sheet with a bank, for example, has become more of a focus for many private market firms."
They state, "While this cash may not be sitting in the business for long periods of time, there is still likely to be a cost of holding such cash, especially given the large sums involved. Money that is held on deposit in a non-interest-bearing account will have a negative impact on the firm’s bottom line since, in real terms, it is constantly losing value. This is why firms in private markets are increasingly turning to money market funds to help them manage short-term cash, and to generate higher yields alongside 'operational alpha' -- the bottom-line improvements linked to higher levels of operational efficiency."
Finally, they tell discuss, "Why MMFs and private market firms are a perfect fit." They explain, "The specific requirements of private equity and private credit managers mean that MMFs are ideally suited to addressing their cash management needs. Short-term holdings: although private market firms tend not to hold onto cash for periods much longer than a few weeks, MMFs welcome short-term holdings -- even if they are just for a few days." Factors also include: High liquidity, Wide diversification, Operational efficiency and technology, and Broad availability.
In other news, the Federal Reserve Bank of New York's "Liberty Street Economic" blog recently featured an update on "The Rise in Deposit Flightiness and Its Implications for Financial Stability," which took a look at recent runs on uninsured bank deposits. It says, "Deposits are often perceived as a stable funding source for banks. However, the risk of deposits rapidly leaving banks -- known as deposit flightiness -- has come under increased scrutiny following the failures of Silicon Valley Bank and other regional banks in March 2023. In a new paper, we show that deposit flightiness is not constant over time."
The blog explains, "In particular, flightiness reached historic highs after expansions in bank reserves associated with rounds of quantitative easing (QE). We argue that this elevated deposit flightiness may amplify the banking sector's response to subsequent monetary policy rate hikes, highlighting a link between the Federal Reserve's balance sheet and conventional monetary policy."
It tells us, "Existing research on deposit stability has focused on differences across deposit types. For example, wholesale and uninsured deposits have long been recognized as more prone to flight than retail and insured deposits. Our findings suggest that aggregate deposit flightiness also varies significantly over time."
The study states, "Depositors' flow sensitivity increased following the 2008 financial crisis, declined in the mid-2010s, but rose sharply after the onset of the COVID-19 crisis. By early 2022, deposit flow sensitivity had reached record highs, meaning deposits were more likely than ever to respond to changes in interest rates just before the Federal Reserve began its rate hiking cycle."
It adds, "This account-level data also reveals that depositors who are more sensitive in moving deposits across their accounts at different banks also more readily transfer funds between their bank accounts and alternative investments, including nonbank financial institutions (NBFIs) like money market funds."
Liberty Street also says, "We show that at any given time, the investors who choose to hold bank deposits are less sensitive to interest rates than those who opt for alternative investments, such as money market funds. We further show that, when deposits flow into the banking system, they tend to be more rate-sensitive than the existing depositor base, making the overall deposit base more flighty."
Finally, they tell us, "Our findings indicate that deposit composition and flightiness are not static but instead evolve in response to central bank policies. In particular, we uncover a novel interdependence between conventional and unconventional monetary policy: if policy rate hikes occur during periods when reserves and deposits are higher following QE, then the risk of deposit flight may be enhanced -- how much depends on the way banks manage the risk and invest their assets. This interdependence between deposit flight risk and QE arises because the entities that provide much of the funds during QE-related deposit expansions tend to be more rate sensitive, amplifying the risk that these new depositors leave en masse to seek higher returns in response to subsequent rate hikes."
