Northern Trust posted an article, "It's Time to Weigh the Risks of Your Cash Strategy," which examines liquidity trends, and opportunities, ahead of the October 14 implementation date for MMF reform. It features commentary from Peter Yi, Director of Short-Duration Fixed Income, and discusses new ways to think about cash segmentation, balancing risks and rewards, and customized solutions for investors. Also, JP Morgan Securities' discusses "Sticky Deposits" in their latest "Short-Term Fixed Income" commentary, which examines the likelihood of bank deposits moving to money market funds in this regulatory environment.
Northern's article explains, "Cash is an expensive insurance policy. As the industry and investors alike grapple with the soon-to-be new reality of money market fund reform, the cash management experts at Northern Trust Asset Management believe it is time investors rethink their cash strategies. To date, much of the industry has been focused on the mechanics of the rule changes: How will redemption gates and liquidity fees affect investors' access to liquidity? How will the industry meet investors' liquidity needs?"
It says, "But Northern Trust's Director of Short-Duration Fixed Income, Peter Yi, CFA, believes now is an opportune time for investors to benefit from the trends and opportunities taking shape within the marketplace. "Even with the introduction of new regulations, we don't expect the day-to-day experience of money market fund managers and investors to meaningfully change," Yi said. "The bedrocks of a money market product will be preserved, which includes having access to daily liquidity and focusing more on principal preservations with a competitive yield."
Northern adds, "As the current Chairman of the Investment Company Institute's Money Markets Advisory Committee and a senior leader at one of the industry's largest cash managers, Yi has been at the forefront during this monumental period of change. He and his team have worked alongside regulators and industry peers to review, evaluate and respond to rule changes. "This is a transitional period for the money market fund industry," Yi said. "We anticipate that there will be a segment of investors who transition back into prime funds once they become comfortable with the new regulations and start searching for a higher return than a government money market fund can provide.""
The piece explains, "But, the best way for investors to navigate new changes is to adopt a cash segmentation strategy ahead of the October 2016 rule implementation deadline. "A cash segmentation framework allows investors to achieve a better balance between risk and reward," Yi said. "It's a more effective way of managing cash holistically." The strategy relies on three buckets, each with its own distinct risk, return and liquidity characteristics."
"Thinking about the gating concept that's about to go into effect, if a fund's liquid assets fall below a minimum threshold and a 'gate' is implemented, your access to the assets may be limited and you may not be able to rely on that money market fund for your operational cash," Yi said. "So rethinking cash lets you allocate some of your cash into these different buckets. Before, you may have had 100 percent of your cash in operational, but now if some of your money market funds are under scope of a gate or a variable NAV, maybe it's no longer applicable for operational. Maybe it's more applicable to reserve."
Northern's piece goes on, "Cash management plays a critical role in a balanced asset allocation by providing liquidity or stability in an overall asset allocation. "Cash gives you the flexibility to be opportunistic in the marketplace," Yi added. The allocation to cash can protect the principal for part of a portfolio. This stability can help offset the impact of volatility elsewhere. "By having a portion of the portfolio readily accessible, this acts as a buffer, protecting other investments in more volatile asset classes from having to be accessed in the event of a liquidity crisis," he said."
Furthermore, it says, "And within a cash segmentation strategy, the operational cash can act as that buffer, providing some protection for the allocation to the strategic cash bucket. Holistically, this can allow for higher yields without exposing investors to inappropriate levels of risk. "Yes, cash is an expensive insurance policy," Yi said. "Markets fluctuate over time, but investors stand to benefit when they work with an experienced investment manager. At Northern Trust Asset Management, we have remained steadfast in our investment philosophy and in our focus on finding the right solutions for investors."
Northern continues, "Some investors likely will move toward exempted government funds in order to maintain a constant NAV on their assets, while others will move -- or already have moved -- further along the maturity spectrum, seeking higher yields and a better risk/reward balance. This journey toward longer maturities can extend beyond cash/money market products into the ultra-short maturity segment of fixed-income strategies. The key is to find the optimal risk/reward balance, and many investors have found an ultra-short fixed income strategy to be most consistent with this need, enhancing their high-quality short-duration exposure."
Finally, it adds, "There's no one-size-fits-all approach for meeting investor objectives, so it's important to provide investors with liquidity solutions, not just standardized cash management offerings. "We can customize our cash suites in ways that supplement our product," he added. "Our focus is on educating clients, providing guidance and customizing our products wherever suitable." We continue to explore product developments to address liquidity needs in this changing industry, and we are committed to ensuring investors have a voice in our product evolution."
Also, JP Morgan Securities' Alex Roever, Teresa Ho and John Iborg wrote recently on deposits, saying, "Last year, one of the issues that concerned money market participants was the possibility that deposits could flood the money markets. As regulations incentivized banks to shed them off balance sheet, a large inflow into the money markets would overwhelm an environment that was already short on investible supply, significantly suppressing yields. Yet, the concern proved largely unfounded as bank data suggests that the money simply shifted from large US banks to smaller US banks over the course of the past year."
They continue, "Still, the concern about deposit outflows remains. Over the past seven years, the amount of deposits in the US has grown by a staggering 50% as the Fed engaged in a series of quantitative easings. As of April month-end, there were roughly $12tn of deposits in the US, most of which belong to large US banks as depositors favored larger institutions over others. As banks continue to optimize their balance sheets, particularly in the current financial environment, it's possible that more unwanted deposits could be shed to continue to boost the firm's regulatory ratios and/or return on equity. It's also possible that depositors could be incentivized to leave the banks for other higher yielding cash substitutes as the Fed raises interest rates. That being said, we think the likelihood of deposit outflows in the near-term is low."
JPM's piece adds, "Just looking more in depth into the composition of deposits, there is a sizable portion of deposits that we estimate is retail.... Under Basel III, retail deposits are viewed as more stable and hence are treated more favorably under various capital and liquidity rules. To that end, banks, and particularly large US banks, have sought to hold a greater portion of these retail deposits.... Additionally, given the current expected path of interest rates, it's unlikely that depositors would be incentivized to move into the money markets in the near-term either."
They explain, "Historically, during prior tightening cycles, flows into MMFs would increase as yields on MMFs become more competitive relative to bank money market accounts. However, we are experiencing one of the slowest tightening cycles in history. Markets are currently not pricing in a second rate hike until 3Q2017. And while yields have picked up in prime MMFs given liftoff last December, we don't think it's sufficient to pull depositors into MMFs given upcoming reform changes. On the government MMF side, yields also remain very low and are likely going to remain low as cash rotates from prime funds into government MMFs due to reform, thereby lessening the appeal of government MMFs relative to deposits."
Finally, they conclude, "Ultimately, bank deposits are likely going to be stickier than during prior tightening cycles given the need for banks to hold certain deposit types and the lack of attractive suitable alternatives. At a price, deposit money may move to the money markets, but we do not expect such a shift to take place to any great extent any time soon."
