Both Fitch Ratings and Standard & Poor's Ratings Agency released 2016 outlooks for triple-A rated money funds and the U.S. and global money market mutual fund sectors this week. Fitch gives the money market fund industry a "Stable" rating for 2016 in its new "2016 Outlook: Money Market Funds." The press release, entitled, "Consolidation, Shift to Alternatives, Divergent Rate Paths Key Themes for Money Funds in 2016," explains, "Fitch Ratings says money fund managers' active management of credit, market and liquidity risks underpins its stable outlook for the sector. However, the sector faces several headwinds, including low or negative yields, constrained investment supply, and the impact of regulatory reform globally." We review Fitch's outlook, as well as the new Standard and Poor's publication, entitled, "Identifying The Shifting Sands For Money Market Funds In 2016," below.
Fitch's release explains, "Fund managers in the US are repositioning cash management offerings ahead of the implementation of money fund reform. Fitch expects alternative liquidity products to grow as well as a shift to government assets, as investors reassess floating NAV US prime money funds. In Europe, discussions on money fund regulation continue, although the final form and timing are not settled. Fitch expects further consolidation of money funds and asset managers active in that space in 2016 driven by the cost of reform implementation and sustained low yields. The low yield environment is particularly acute for euro money funds, even as investors are beginning to accept negative euro money funds yields due to the lack of alternatives."
They write, "A shift of assets from prime funds to government funds is likely, as many investors dislike the new floating NAV and fees and gates features of prime funds. In many cases fund managers are converting funds from prime to government to pre-empt potentially disruptive investor redemptions and the operational challenges of the new features. So far USD240bn of prime fund assets are slated to convert to government assets, or 15% of the USD1.6trn in total prime funds' assets at end-September 2015. Investors may shift cash out of prime funds in the first or second quarter of 2016, but so far there have been no significant flows."
Further, it says, "Market participants expect interest rate paths divergence in the US/UK versus the Eurozone. Money funds will shorten their duration in anticipation of their expectations of the Federal Reserve and the Bank of England to start raising rates in late 2015 and 2016, respectively. The European Central Bank continues to ease monetary policy, forcing euro funds to contend with negative yields. Credit quality for the banking sector is stabilising as Fitch has completed its review of sovereign support assumptions in most European, Swiss, US and Canadian bank ratings to reflect newly-adopted bank resolution regimes. Banks will remain an important segment of eligible issuers for money funds, albeit declining in portfolios' allocation as Basel III rules discourage banks from obtaining short-term funding."
The piece adds, "Fitch believes money funds will pursue further reallocation towards securities issued by sovereigns, supranationals and government agencies (SSA), non-financial corporates or, in the case of large US money funds, the Fed's reverse repo programme. The expected flows into government money funds in the US will pose a challenge as the available supply and yields on government assets remain low. The USD4.6trn of global money fund assets predominantly reside in the US and Europe; however, money fund products are growing in other markets, most notably in China, which now comprises 8.5% of global money fund assets."
S&P's report says, "Years ago, the advantage of operating in the short-term, money market fund (MMF) industry was that negative events could be fleeting. A credit event or change in monetary policy would seemingly hit the short-duration markets quicker than expected and then was gone, sometimes leaving a mark but generally not staying long enough to cause permanent pain. In the past several years, we've seen significant changes in the MMF industry. Prior to 2007, most MMFs and local government investment pools had sporadic fire drills. They made the occasional misstep, an inverse floater here, a toggle bond there, and even, perhaps, a funding agreement lurking behind a closed door. But these are different times. Shifts in the operating conditions for MMFs seem to have more staying power and certainly are proving to shape the industry more than ever before."
It continues, "Indeed, in Standard & Poor's Ratings Services' opinion, 2016 promises to be an eventful year for short-duration investors. Some of the industrywide issues, such as implementation of regulatory reform, may cause a shudder of dread, while others promise some hope -- such as a possible U.S. interest rate hike in the near term. We expect such issues as liquidity, fee waivers, and looming credit events to not only keep investment managers on their toes, but to also make the upcoming year a memorable one for the industry. Each of these could pressure how these funds operate, and while managers in this space have historically shown an ability to properly balance themselves in the midst of shifting sands, that's not to say that will be the case this time."
Finally, in a section entitled, "Saying Goodbye To Fee Waivers," S&P comments, "After nearly a decade of coping with low rates of return, there appears to be a light at the end of the tunnel. After years of waiving fees and adjusting expense ratios so that their MMFs return something, anything, to shareholders, U.S. MMFs are finally seeing some movement in longer-term rates, buttressing their hopes for growth in gross yields. Certainly, the rise in gross returns is nothing dramatic, but when discussing the difference between 1 basis point and 3 basis points, well, everything is truly relative. If nothing else, it is providing a ray of hope to what has otherwise been a dreary operating environment. The number of firms over the past decade waiving a portion of their fees had risen to the point that by 2011, it was virtually 100% of those operating government institutional, prime institutional, and tax-free MMFs."
