Several large money managers have announced lineup shifts this year in response to new money market fund regulations, and it's likely that more will follow in the coming months. Mutual fund publication, Ignites, explored the new landscape in a webinar it hosted last week, entitled, "How Firms are Revamping Their Fund Lineups." The 45-minute session was moderated by ignites Managing Editor Beagan Wilcox-Volz and featured panelists Rick Holland, Head of Money Management and Fixed Income Funds Product Management at Charles Schwab, and Peter Crane, President of Crane Data.
Just a month ago, Fidelity announced that it will be converting three Prime funds to Government funds due to reforms, including the $112 billion Fidelity Cash Reserves. Also, Federated announced that it will be converting some of its Prime Institutional funds to 60-day maximum maturity floating NAV funds, funds that likely won't float because of the short duration. When asked if the SEC rules and subsequent product changes like these would lead to an increase or decrease in MMF assets, 81% of the webinar audience said it would lead to a decrease in MMF assets, with 67% of that total saying a slight decrease. About 19% said assets would increase, while 17% expected a substantial decrease.
Crane agreed with the minority "increase" camp, due primarily to forces not related to SEC MMF reforms. "I'm going to go with the under. The last several years people have been predicting large outflows from money funds and the assets have been basically flat. Within money market funds there's clearly going to be a lot of shifts and a lot of pressure to move towards government. But there are external factors that I believe are going to be pushing an awful lot of money into money funds from bank deposits and bonds." Citing a recent article in The Wall Street Journal on the subject, Crane said new banking regulations could discourage large banks from holding deposits. "I don't think it's out of the question that $1 trillion moves out of bank deposits over the next few years."
Crane also predicted that as much as $500 billion could move out of bond funds, depending on the direction of interest rates, which are expected to go up this year. "I also don't think it's crazy to say there may be big flows from bond funds -- which have doubled in assets since 2008. They are now $3.5 trillion, so there's almost $2 trillion that's flowed into bond funds seeking more yield over the last several years."
Crane showed a chart that illustrated the asset breakdown of money funds. Of the $2.7 trillion total, the largest chunk, about one-third or $900 billion, is in Prime Institutional while nearly $600 billion is in Prime Retail. "One of the big variables we're going to be dealing with going forward is the reclassification of Prime Institutional and Prime Retail and that's expected to slice off at least 5-10 percentage from Prime Institutional." He asked, `Of that $1.5 trillion in Prime Institutional and Prime Retail, how much is going to move into government? Holland believes that the volume of flows depends on the type of money fund. "To the degree that your business is heavily skewed toward retail investors, you are less likely to experience significant outflows from money market funds than you would be if your client base is exclusively or predominantly institutional."
Schwab is among the many MMF managers that have not yet announced any changes as a result of the rule changes, but Holland discussed the factors his firm is weighing. "From the initial stages of this debate about the need for additional money fund reform, the discussion has rightly focused on the fact that institutional and retail shareholders behave differently. We feel it's appropriate that the decision about product offerings and enhancements are made with the new definitions of retail and institutional investors in mind. The vast majority of our client base, 80%-90%, is comprised of what will now be defined as retail shareholders who will very likely qualify for the retail exemptions. Life doesn't change that much for them."
He adds, "However, we do have institutional shareholders and we are in the process right now of identifying which additional products we will need to create for those investors. Secondly, the vast majority of our shareholders use money market funds in a sweep capacity as opposed to a position-traded or a purchased money market fund. The complexities of offering a VNAV in a sweep versus a position-traded fund are paramount and we have to consider those complexities when we look at whether or not we would offer product in both of those fund types."
Holland continues, "Our shareholders look at money funds as the best method of preserving capital, providing liquidity, and giving them transparency. We want to be sure that our clients, both on the retail and the institutional side, have a variety of ways to accomplish those objectives. Lastly, we feel that a high degree of education is appropriate at this point in time to insure that clients understand what the rule is about, what their options are, and the timetable under which we need to comply on their behalf."
In the Q&A portion of the session, one audience member asked if there will be a shift to Ultra Short Bond Funds. Crane responded, "Ultra Shorts to date have attracted a lot of assets, in the hundreds of billions. But they haven't attracted trillions, and the reason is that they are not giving a substantial yield advantage over money market funds. The risk of losing money to the VNAV isn't worth another 25 basis points to people. But higher rates could be the best thing that happens to them."
He added, "Fund companies have been out there selling the theme of putting cash in different buckets and my impression is that investors haven't been buying it. But going forward, if you get a 50 basis point spread between government funds and prime funds, and you get another 50 basis point spread between prime funds and Ultra Short funds, I believe that enough people will start bucketing their cash and putting money into Ultra Shorts.
There was also a question about "60-day maximum maturity" funds and whether they would generate interest. Crane answered, "This is dependent on rates scenarios and supply as well. Federated has been pushing this idea, and Invesco has had a 60-day product out there, the STIC Prime Fund. The question is, is there enough yield over a government fund to make it worthwhile? If you're getting 20 or 30 basis points over a government fund, and if a ton of money moves into the government segment and really flattens those rates, then it looks like the 60-day funds are going to be viable."
Another audience member asked about supply in the government money fund sector, or lack thereof, if there is a mass movement from prime to government. Holland said, "I think that's a real concern and certainly some of the activities that we have seen by some fund sponsors would lead us to believe that it would be wise to keep our eye on that ball. But from our perspective, looking at the retail shareholder, life doesn't change that much for them if they stay in a prime money fund, and we are of the opinion that a lot of our shareholders will continue to do just that. I do think that the potential for flows from retail prime into government has possibly been overstated and I think we'll have a little bit of relief there in terms of supply."
Crane added, "The Fed says that its Reverse Repo Program will continue [for now]. But if that thing goes away, there's no room for anybody in the government space. There are major issues with supply in the current environment, let alone some future actions that could shift things so it becomes a real squeeze."
Finally, on investors' concerns about gates and fees, Crane states, "The no-brainer is to go government, but you may want to keep that prime option open. We've come through a period of 6 years where investors were looking for safety and have become "de-sensitized" to yield. But investors at some point will become "re-sensitized" to yield. All of a sudden, if there are [as expected] 50 or 100 basis point spreads, they will care, and money [will] start moving." He continues, "As people learn about the gates and fees -- and I always use the term "emergency gates and fees" because these things are only going to be used in a major event -- [they'll realize that only] a September 2008-type scenario, where 20% of your liquidity is stripped away in the course of days, will trigger these."
