Today, we review two recent updates from Fitch Ratings, as well as three briefs from Moody's Investors Service. Fitch's "2018 Outlook: Global Money Market Funds" discusses liquidity, flows back into Prime MMFs and European regulatory reforms, while their "Prime Funds Growing Despite Narrowing Spreads" release also focuses on Prime flows. Meanwhile, Moody's released updates entitled: "Q3 2017 Update: US prime funds gain momentum against backdrop of stability," "Sterling: Sharp decline in assets, market risk exposure rises," and "Euro: Assets under management fall, liquidity rises." We excerpt briefly from all of these new pieces below.
Fitch's "2018 Outlook" says, "Liquidity will remain a key focus for investors in 2018 with fund managers in the U.S. continuing to conservatively manage their portfolios to avoid triggering liquidity fees or redemption gates, likely targeting roughly 40% weekly liquidity. European funds will build liquidity as European money fund reform approaches and funds begin to transition. Fitch Ratings' expectation of funds' maintenance of appropriately high liquidity supports our Stable Outlook.... Requirements to hold higher levels of weekly liquidity invariably led to a commensurate reduction in fund yields. Managers will face pressures to appropriately balance liquidity with the search for higher yields."
It notes, "Fitch expects recent modest movement back into prime funds to continue, although the pace will be hindered by the small size of the funds that remain. Fund managers will continue to offer prime funds as higher yielding alternatives to government money funds to attract investors back into the space.... A silver lining of the U.S. shift from prime to government funds is the markedly improved supply-demand dynamics for the remaining assets in prime funds. Conversely, government money funds are in a more difficult position, given the significant inflows they experienced. One bright spot is the high capacity of the Fed's reverse repo program."
The report continues, "The main risk European money fund reforms pose to ratings is from unexpected disruption during the transition process. However, we expect fund managers to take steps to mitigate risks, including strengthening liquidity during the transition. The new rules will not change our approach to rating money funds and therefore should not directly affect ratings unless funds' underlying credit, market or liquidity risks increase."
Regaring Chinese money funds, Fitch says, "We expect the impact of the new regulations on Fitch-rated Chinese money funds to be limited. Consistent with Fitch's money fund rating criteria in China, 'AAAmmf(chn)' rated funds already operate with significantly higher credit quality, more liquidity and lower maturities than most unrated funds.... Chinese money fund AUM grew 20% over the year to mid-2017 to approximately USD800 billion. This makes China the second largest individual money fund domicile globally. The Chinese money fund sector is concentrated with the largest fund (Yu'eBao)."
Fitch also released an update on "Prime Funds Growing." It says, "A year after reforms caused over $1 trillion to flee the space, U.S. prime money funds continue to show slow but steady growth -- even as spreads between prime and government fund yields narrowed from their March 2017 highs. Net yield spreads between prime and government funds fell to 0.26% in September from 0.33% in March but Fitch Ratings expects growth to continue despite investor concerns about NAV stability and fees/gates and the small size of many funds. On Sept. 29, prime fund assets were $440 billion, up 19% over last November."
The piece adds, "The return to prime funds contrasts with some other gauges of investor sentiment. In a recent AFP survey, 43% of investors said they would require a yield spread greater than 0.50% to consider returning to the funds, while another 40% said no amount of spread would justify a return to prime funds given their new features. Institutional prime funds have exhibited NAV stability since moving to a floating NAV, which should partly mitigate investors' principal preservation concerns. Since the reforms, 96% of observations of daily changes in institutional prime fund NAVs have shown no movement and 4% showed NAV moved up or down by 1 basis point (bp). In a few cases NAV moved by 3 bps or more in one day."
Moody's first Q3 update says, "Assets of the surveyed group of US prime money market funds increased $18.9 billion during the quarter, up 24.8% sequentially. As expected, the yield spread between US prime and government funds remained range-bound and was 26 basis points at quarter end. The stable yield spread indicates that higher asset levels are less a function of incremental yield over government funds, and more so due to growing investor confidence in variable net asset value (VNAV) prime funds.... US prime fund flows have now been positive for five consecutive months, with year-to-date inflows of $31.2 billion. We expect this trend to continue given the seasonality of corporate cash balances and our positive yield outlook for Q4."
It continues, "The average stressed net asset value of the surveyed group reached 0.9930 at the end of September, reflecting stronger portfolio credit quality at quarter end relative to prior periods. Approximately 65.9% of assets managed by the surveyed group were rated Aa and higher, up 4.7% sequentially. This indicates a reversal of a trend which saw US prime fund managers take on additional market risk following the implementation of amended Rule 2a-7 last October. The modest reduction in market risk exposure was also a function of rising liquidity, a trend which we expect will continue into Q4.... Repo exposure for the surveyed group increased to 25.5% during the quarter, reflecting strong supply. CD exposure declined to 22.9% as fixed rate issuance was limited."
Moody's second article states, "Sterling prime funds' assets under management fell to a 12-month low of L147.2 billion in Q3. The decline reflected large outflows of L20.2 billion (or 12.1% of assets) amid persistently low yields. Despite these outflows, net redemptions from sterling prime rated funds exceeded 10% of total assets only once (0.1% frequency) during Q3. The frequency of such redemptions will be closely watched when new European Union (EU) money market fund regulations take effect next year. Under the new rules, the directors of new low volatility net asset value (LVNAV) funds will have the option of introducing fees and gates if a net redemption above 10% coincides with a weekly fall in liquidity to below 30%."
Moody's third brief says, "Euro prime money market funds' (MMFs) Q3 assets under management (AUM) fell to a 12-month low of EUR60.4 billion. The decline reflected large outflows of EUR4 billion (6.2% of assets), amid persistently negative yields. On 26 October 2017, the European Central Bank (ECB) left its main interest rates unchanged.... While the yields of euro-denominated CNAV funds stood at record lows at the end of Q3 (-49 basis points, 1 basis point lower than in Q2), the pace of the decline in yields has slowed."
Finally, they note, "Net redemptions from euro prime rated funds exceeded 10% of total assets only twice (0.4% frequency) in Q3. The frequency of such redemptions will be closely watched going forward as the board of directors of the new low volatility net asset value (LVNAV) funds will have the option under the new EU regulation of introducing fees and gates if a net redemption above 10% coincides with a weekly fall in liquidity to below 30%."
