Invesco Fixed Income posted a recent "Investment Insights," entitled, "Prime Institutional funds may offer renewed value in a post-ZIRP, post-reform world." Written by Robert Corner, senior client portfolio manager, it says, "Yields of floating net asset value (FNAV) prime institutional money market funds have increased and may now offer an attractive relative value opportunity. Following many years of zero interest rate policy (ZIRP) and recent money market fund reform implementation, we believe the yield advantage of prime institutional funds has increased enough to compensate investors for political fluctuations in FNAVs. And to reduce the risk of being subject to potential liquidity fees and redemption gates (fees and gates), we believe investors should consider segmenting their cash investments." We excerpt from the Invesco paper below, and we also look at the recent upturn in Prime fund assets.
Invesco's piece explains, "We have been asked by clients whether there is value in FNAV prime institutional funds in the new, post-reform, world of money market fund investing? In this short article, we attempt to answer this question by highlighting three key factors we believe institutional investors should evaluate when considering a prime institutional fund." These include: Yield, Net Asset Value (NAV), and Fees and gates.
It continues, "Yields of FNAV prime institutional funds have increased and we believe these funds may now offer an attractive relative value opportunity for investors who have a large concentration of their cash in bank deposits and government institutional money market funds.... Historically, prime institutional money market funds have tended to provide a higher yield than government institutional money market funds.... However, during the post-financial crisis era of zero interest rate policy (ZIRP), the yield advantage of prime institutional funds over government institutional funds compressed as many government funds waived expenses to maintain their yields above the zero bound."
Corner tells us, "In 2016 the typical yield advantage of prime institutional funds reappeared after the Federal Reserve (Fed) raised monetary policy rates in December 2015. As a result, the average yield spread of prime institutional funds versus Government institutional funds increased to an average of 16 basis points in 2016 after averaging just 3 basis points over the preceding five years.... As of Dec. 27 2016, after significant outflows from prime institutional funds due to reform and another rate hike by the Fed, the average yield advantage of prime institutional funds over government institutional funds jumped 30 basis points. These higher relative yield levels currently provide an opportunity for investors to reconsider prime institutional funds."
He says, "We believe the yield advantage of prime institutional funds could remain near its current high or rise further (i) as investment managers adjust strategies in a more normalized post-reform world, (ii) if supply and demand dynamics of government securities keep government yields relatively suppressed and (iii) if the Fed keeps interest rates comfortably above the zero bound."
Corner explains that, "Variation in FNAV could be tolerable," writing, "Transacting at a floating net asset value (FNAV) is relatively new to prime institutional fund investors, but the reality is that the underlying market value of money market funds has always fluctuated. Recent money market fund reform took valuable steps to improve the transparency of money market funds. In 2010, funds were required to track their 'shadow' price, or market value NAV. In April 2016, funds were required to disclose on their web sites at least six months of market value NAV history."
He adds, "If a recent history is any guide, the NAV fluctuations of prime institutional funds are likely to be relatively well contained under normal circumstances, in our opinion. We reviewed six months of market NAV history of 32 FNAV prime institutional funds as of Dec. 30, 2016. The median range was +/- $0.0002. Regarding the one outlier fund that moved by +/-$0.0009, that fund also paid a capital gain distribution of $0.0007. Based on this history of subdued volatility, we believe investors should take a fresh look at prime institutional funds if NAV volatility remains in a narrow range and their yield advantage continues to provide enough of a cushion to help minimize the potential impact of changes in FNAVs."
Invesco also says, "Investors concerned about the potential for fees and gates may consider segmenting, or bucketing, their cash investments by liquidity priority. Under new Securities and Exchange Commission (SEC) rules, the maximum length of time a fund can enforce gates is 10 business days. With these new rules in place, a basic 'cash segmentation' implementation strategy would be to have at least 10 days of cash, plus a cushion for uncertainty, invested in securities not subject to the SEC's new fees and gate rules."
They add, "For example, cash that is absolutely necessary on a day to day basis, or on very short notice, could be invested in bank deposits and government money market funds while excess cash balances that ate not expected to be utilized in the short run could be deployed into prime money market funds to achieve a higher return. We believe this simple cash segmentation strategy is an easy method to circumvent being caught short by the unlikely probability of a fund imposing fees or gates."
In other news, J.P. Morgan Securities says, "MMFs may be seeing early signs of cash creeping back into the prime universe," in its latest "Short Duration Strategy Weekly. It explains, "Anecdotally, we've heard of a few funds who anticipate modest inflows as investors become more comfortable. Furthermore, it looks as if the yield spread between prime and government funds is drawing some money into prime. Since the Fed hike this spread has widened about 11bp, appearing to have lured about $10bn into prime MMFs."
Crane Data's latest Money Fund Intelligence Daily product shows Prime assets up by $5.0 billion in the latest week and $10.1 billion month-to-date through Jan. 23. Prime Institutional assets have increased by $5.5B over 7 days and $11.5B MTD. Prime Inst MMFs are now yielding 0.52%, 27 bps over Treasury Inst MMFs (0.27%) and 22 bps over Govt Inst MMFs.
