Moody's Investors Service released the Industry Outlook "Money Market Funds 2010 Review and 2011 Outlook" last week, which was subtitled, "Credit, Interest Rates, and Regulatory Uncertainties to Define the Year." The 18-page report, written by Senior V.P. Henry Shilling and Senior V.P. Daniel Serrao, summarizes, "Our credit outlook for money market funds in 2011 remains stable, based on our view that volatility in general has diminished and conservative portfolio practices carried over from 2010 will persist into this year. Forces that shaped portfolio investment strategies last year will continue to dominate. They include historically low yields, credit, and sovereign concerns, and most recently geopolitical instability, supply constraints, declining assets under management (AUM), regulatory uncertainties, and further industry consolidation.
Moody's press release on the report, titled, "Money market funds outlook remains stable", comments, "The credit outlook for money market funds in 2011 remains stable, Moody's Investors Service says in its just published industry outlook. The rating agency notes that volatility in money market funds generally has diminished, and that the conservative portfolio management practices seen in 2010 likely will persist this year."
Shilling says, "The risk profile of money market funds has been dialed down in the past year. Funds are more liquid, assets' maturity-adjusted credit quality is higher and their average maturities have been reduced.... While we expect that proposed reforms, if enacted, will make the system safer for investors, they could also reduce the attractiveness of money market funds, in some cases by increasing costs and lowering yields."
The report explains, "[R]isks to funds might escalate later in the year due to rising interest rates and shareholder redemptions, while a combination of the two could cause net asset value (NAV) stress. The money fund industry also still faces regulatory risks, as concerns about its potential to destabilize the broader financial system could lead to reforms that transform the industry. These reforms could include the introduction of variable net asset value money funds or a two-tier system of money market funds with better protections for constant net asset value (CNAV) funds via a liquidity facility and capital buffers. Regardless, these developments are potentially credit positive for rated funds."
It continues, "Looking ahead, the following considerations are likely to continue to dominate the money market funds sector and management firms in 2011: Historically low interest rates and near-term interest rate risks. Short-term interest rates are expected to remain at exceptionally low levels for the remainder of the year. But even with the imposition of the 60-day weighted average maturity (WAM), 120-day weighted average life (WAL), and one-to-seven day liquidity constraints, funds that engage in maturity extension via a barbell strategy could be exposed to incremental risk if interest rates unexpectedly move sharply higher and at the same time investors withdraw funds in favor of higher yielding direct or alternative investments."
Moody's says other considerations include: Credit uncertainties coupled with supply constraints. Credit conditions are expected to continue to challenge money market portfolios in the United States as well as overseas.... By our estimates, in excess of two-thirds of U.S. prime and tax-free money market funds, on average, are directly or indirectly exposed to banks, which is expected to continue to constrain approved securities lists and contribute to uncertainty.... Portfolios are more conservatively positioned generally and we expect this to persist. Credit, supply constraints, yields, and regulatory developments, as well as liquidity and fund flows, have helped shape the portfolio profiles of prime money market funds, and, to a lesser extent, those of tax-free funds. This is expected to extend into 2011."
Additional considerations are: "Liquidity management. At December 31, 2010, U.S. rated prime funds reported an average seven day liquidity position of 43% of total net assets, while for non-U.S. funds, across U.S. dollar, British pound sterling (GBP), and Euro currencies, the corresponding number was 36%.... Volatility in assets under management (AUM). While funds suffered from the migration of assets to banks, separate accounts and other alternative and in some cases riskier higher yielding investment products, for a total of $500 billion in net outflows during 2010, institutional assets in money funds have been bolstered by corporate investors who are maintaining significant cash balances on their balance sheets.... Regardless, we expect further erosion in total net assets in 2011."
Finally, Moody's lists as "considerations" for the outlook in 2011: Regulatory developments create uncertainty and Continuing consolidation. The report says, "The adoption and implementation to-date of various amendments, guidelines, and rules have already reduced the risk profile of money market funds in the U.S. and Europe, but funds and their management firms continue to face regulatory uncertainties. These center around options designed to reduce 'run risk' and related systemic risk. Whatever the outcome, they support stronger protections for investors at the expense of money fund sponsors but are viewed as credit positive for rated money funds. Investors, however, might be faced with higher fees in the intermediate to long-term. In any case, regulatory uncertainties could even extend into 2012.... The consolidation trend among money market funds in the United States is expected to continue due to rising operating costs and fee waivers combined with potential capital charges, liquidity charges, and potential costs in the form of parental support in the event of adverse credit developments."
