"What would you do with a trillion dollars?" That was the question from conference host Peter Crane that kicked off the session called "Government and Treasury Money Fund Issues" at last month's 7th Annual Money Fund Symposium in Minneapolis. Government money funds are poised to pick up hundreds of billions of dollars in assets come October 2016 when SEC reforms go live. Some say it could be as high as a trillion when you factor in money migrating from Prime money funds and bank deposits, both of which face new regulations. Government money market fund portfolio managers Michael Bird of Wells Fargo Advantage Funds, and Susan Hill of Federated Investors, shared their thoughts on the "Govie" Fund space. The session was moderated by Citigroup Fixed Income Strategist Andrew Hollenhorst and featured Jonathan Hartley of the Federal Home Loan Banks-Office of Finance. Also, we report on the challenges and opportunities in the Tax-Exempt money fund space from the session, "Muni & Tax Exempt Money Fund Issues," featuring Colleen Meehan of Dreyfus, John Carbone of Vanguard, and Isaac Fine of Fidelity Management and Research. (Note: Next year's Money Fund Symposium will be June 22-24, 2016, in Philadelphia, but we'll be hosting our next European Money Fund Symposium in two months, Sept. 17-18, 2015, in Dublin.)
In the Symposium "Government" fund session, Hollenhorst talked about the possible flows into the space. "I don't think anyone has a good number on the amount of demand that we will see for government securities, but we expect that it will increase substantially. All we can do at this point is try to ballpark what the potential demand will be. It's ultimately the end user, investors in money funds, that will determine what that demand is. We can't know what it will be until we see what they decide to do. Initially, the discussion was around outflows from Prime Institutional because of the floating NAV, but a lot of the concern has shifted to the gates and fees portion of the money fund reform rather than the floating NAV. So maybe we'll see less from Prime but what caught some of us by surprise is the potential flows out of the retail space."
Hollenhorst continued, "When you do surveys of corporate institutional buyers of money find shares you get a number like 50%, in terms of who is thinking about moving cash. So apply 50% of the institutional prime and you get to a number like $450 billion. If you think there's some outflow from retail prime that number could be even higher. Another potential inflow into government funds could come from bank deposits. Some large banks announced that they're trying to reduce deposits on their balance sheet by as much as $100 billion, that's just one bank. If you apply the same ratio of the deposit reduction that we heard from that one bank to the rest of the large banks you could also get to a number like $400 billion. I'm not claiming that we're going to see $850 billion in new demand, but I think we have to admit the possibility that we'll see hundreds of billions of flows into this space."
Hill doesn't know how much money will flow into Govie funds, but there is another question. "It's not so much how much comes over, it's how it gets there. If it comes all at once in October 2016, and in big amounts, the front end is going to be stressed. That's probably a bad scenario, but I don't think that's how it's going to happen. We have had open dialogues with our clients so as we get closer to that date we will have an idea of where they want to go and how to get them there. The dollar amount? Your guess is as good as mine. We're hoping that it's not at the extreme of what's been discussed."
The panelists discussed the importance of the Fed's reverse repo facility. Said Hill, "How big does this facility need to be in light of the potential shifts? It needs to be potentially large enough on a daily basis to remove the concern about whether you can get invested." In other words, it needs to be large enough to handle the amount of expected demand. "Obviously it can't be a permanent part of the market and it should be here only as long as it's needed. It needs to be there and it could be needed for a more extended period of time."
Bird commented, "My hope is that when lift-off takes place, it become an unlimited facility and they fully remove the cap. Then maybe adjust it from there based on the usage." He added, "We're hoping that it's going to be around for a number of years, but we do know that at some point it is probably going to go away. So we've begun taking steps to define what's being called non-traditional repo counterparties to expand our direct repo base." In terms of flows, Bird added that while moving from Prime to Govie might be an easy choice now given the small difference in spreads, that could change. "Sixteen months down the road it may be a more difficult choice for them if we see the spread between yields in Prime and Government funds increase."
On Treasury Bill supply, Bird said, "It's going to be a tough environment for the bill market, as we see rates go higher. For those [Treasury-only] funds that can only invest in that product, it's probably going to take a little longer than say a prime fund or a government fund for you to see those yields start to increase." In other words, the spreads between Government and Treasury-only funds could widen. Hill explained, "As we move into the new world, you'll see these Treasury-only funds lag a little bit. You may see more investors look at that alternative if it's a higher yield."
Bird added, "If we're talking about the migration of prime funds potentially into government and treasury funds as we get into the compliance phase of reform, Prime investors already have that risk tolerance to be in a prime fund, and they're comfortable with the credits in the repos. They really shouldn't have much of a problem moving into a Government fund and overlooking the Treasury-only and Treasury plus funds. I think most of the attention in terms of the migration will be towards the Government funds as opposed to the Treasury funds."
In the Muni money fund session, Meehan talked about the ramifications of money fund reforms on the market. "From a market perspective going forward, I think that we are going to mirror the taxable market in the demand for short term highly liquid product, which is the VRDN space. It is going to be very strong, and that's going to keep the rate on the short end very low." She added, "An item that people have been talking about is 60 day and in funds. I think we will see that in the muni space, but I also think we will see 7 day funds." Just as in the taxable space, they will have to be marketed as a floating NAV fund, she said, "But because of that reset mechanism that is in place for those securities, that product will always be priced at par <b:>`_."
Finally, Meehan commented, "Investors have not been in tax exempt funds for the last several years for tax free income. The reason they're in these funds is for diversification. How can we help our clients maintain high quality liquid assets with minimal disruption? I think investors should include muni funds in their overall picture for diversification and also, when we come out with some of these products, to minimize their dependence on government funds going forward." She added, "What keeps me up at night? The lack of understanding of some of these changes that are coming. Our job is to educate our clients to make sure that we're providing our clients with the necessary information and the necessary fund lineup to meet their needs."
