Wells Fargo Advantage Funds' monthly "Overview Strategy, and Outlook" examines recent changes in the repo market and their impact on money market funds. Also, we report on Part 2 of a webinar series from Capital Advisors Group on "Recent Money Fund Developments and Key Issues for Corporate Cash Investors." (Read coverage of Part 1 of the webinar in our April 10 "News," "Capital Advisors' Pan, Campbell on Recent MMF Moves; $615B Outflow?") The Wells Fargo "Focus piece: Repurchase agreements", authored by Jeff Weaver, Head of Money Funds and Short Duration, and his team, explains, "The first part of April was an unusually heavy news cycle for repurchase agreements (repos). These sleepy, white-bread staples of the money markets typically get little press, let alone a spotlight focused on them. However, several events have conspired to bring them front and center."
Wells says, "First, it's unlikely we'd be able to write any piece on the repo market without mentioning the Federal Reserve (Fed), the largest repo counterparty in the U.S. The Fed finds itself on the verge of a tightening cycle, yet meeting minutes suggest there is still some debate within the Fed on exactly how each policy tool will be deployed. It may temporarily increase the size of the reverse repurchase (RRP) facility as it implements its tightening cycle but reduce it soon thereafter. So while there may be initial good news at the beginning of the tightening effort, it is possible that when the Fed contracts the size of the facility, it could be capped at a lower level than it is today -- which would not be good news for program participants."
The piece continues, "This is because, according to The Wall Street Journal, repos and repo collateral have become increasingly scarce due to regulatory policies that were meant to decrease systemic risk and stabilize financial markets but have instead unintentionally resulted in increased price volatility and decreased liquidity! One journalist even went so far as to characterize the fixed income market as broken. Another news article highlighted an additional unintended consequence of the regulatory environment: borrowers and lenders transacting directly without the benefit of a broker/dealer or bank intermediary."
Finally, Wells adds, "Some of these issues are old news and have been discussed to some extent in our previous commentaries.... It is thought that the contractual changes to repos would be a temporary postponement of the early termination provisions and an extension of the automatic stay provision to the collateral foreclosure process. The importance of these proposed changes, and their ramifications for money market funds, is probably best understood by refreshing in our minds the mechanics of repos, how they are used, and their benefits; this would then enable us to follow through with the rule changes and the downstream effects that might need some resolution for investors prior to implementation." The rest of the Wells report features an excellent summary of the repo market, as well as a summary of repo use in money market funds (using Crane Data info).
On the latest Capital Advisors webinar, CEO Ben Campbell and Director of Investment Research Lance Pan looked at the consequences of the SEC money market reforms for investors, particularly corporate treasurers. "If you think of the scope of the changes, they impact every type of investment vehicle," said Campbell. "We view this as a major table reset, and we think it's a very good time to step back and look at the consequences of these reforms and what the new options are and how those would be applied to your objectives."
Campbell said the most likely place for MMF assets to shift in the near term is to government MMFs since they have stable NAVs. "We feel this will have a significant impact given that this represents about a tripling of the government money market assets. If you have $1.0 trillion shifting and the whole market is $7.2T, it's about 15% of the overall supply. We would expect there to be significant decline in the returns of the government securities caused by this factor." He added, "But that's not to say the money will remain there forever. There will likely be a transition period for the market as new products are stress tested and as people move out from the Treasury world."
Pan analyzed some of the options that are available to investors beyond the stable NAV government funds. "First off is Variable NAV prime funds.... But people will have to answer this question -- Is it workable? ... [W]ill institutional investors embrace VNAV money market funds? That's a big unknown, because the product only works if the majority of the shareholders think it will work. Lastly, from a liquidity point of view, do you have the right tools to basically project or monitor whether the weekly liquidity falls below that red line?" The proposed 60-day and 7-day maximum maturity funds are subsets of this category, offering better principal preservation and liquidity than other VNAVs, but with potential supply challenges, he said.
Next, Pan talked about 3c-7 funds, or Private funds. "They are not money market funds; they are structured as a limited partnership," he said. While they can offer a stable NAV. they are not subject to 2a-7 rules and protections such as minimum credit requirement, minimum maturity and duration requirements, transparency, and the concentration of assets. They could also have liquidity challenges. "If you have a limited partnership you may get into this situation where you may have some kind of unforeseen liquidity issues if one of the large shareholders were to pull out," said Pan.
Regarding Ultra Short Bond Funds and ETFs, Pan said, "The rationale here is, if you are not constrained by 2a-7, you can perhaps have more supply, and if you can live with an NAV that floats, why not just go out on the curve a bit more and pick up more yield? The downside is, these products are not subject to 2a-7 protections. You are using these as investment vehicles, not as liquidity vehicles because you will have daily fluctuations much more than the 2a-7 VNAV funds."
Pan concludes, "The last item I'm going to touch on is the direct purchase, separately managed account concept. This is a fairly customized approach," he said. "You basically own the portfolio of securities." Thus, they are not subject to the variable NAV or fees and gates. He added, "We consider them as self-generated liquidity. They do come with pros and cons. The pro side is you don't share the liquidity with anybody else, so you don't have to worry about runs, for example. The con side is you would need to do a bit more homework to plan out your liquidity and leave enough cushion for you for the unforeseen needs in the future." Whichever way investors go, they should make their decisions well in advance of October 2016, said Campbell. "You don't want to wait to the tail end of this to see what happens."
