The slow but steady recovery in Prime assets continues to be the most talked about money fund story of the second half of 2017. Most recently, Invesco, addressed the topic with a paper entitled, "Change Creates Opportunity in US Prime Institutional Money Market Funds," and Capital Advisors Group," discussed it in, "First Annual Checkup on Reformed Institutional Prime Funds." Invesco's piece tell us, "We believe disruption and change in the US money market fund industry has led to a renewed relative value opportunity in US prime institutional money market funds ('prime funds'). In the post-financial crisis era from 2009 to 2016, a seemingly unrelenting barrage of challenges bombarded the US money market fund industry: zero interest rate policy (ZIRP), industry consolidation, reform in 2010, reform in 2016 and a massive shift in assets out of prime into government money market funds. However, past is prologue, and two recent trends have led to attractive valuations in prime funds."
They say these trends include: "1. The US Federal Reserve's (Fed) removal of monetary policy accommodation has led to sharply higher yields on prime funds. 2. A shift of more than USD1 trillion in assets into US government money market funds ... and a resulting supply/demand imbalance in money market securities has led to attractive relative valuations of prime funds."
Invesco's Rob Corner explains, "Absolute levels of US prime money market yields have improved markedly on the heels of four Fed rate hikes since late 2015. These tightening moves have helped push up average prime fund yields to around 1%, after averaging only 0.04% under the Fed's zero interest rate policy from 2011 to 2015.... We believe yields on US money market funds could continue to increase in the months and years ahead if the Fed stays on its current path of removing monetary policy accommodation, based on a strong correlation between monetary policy rates and US money market fund yields."
He continues, "The average yield advantage of prime funds over government institutional money market funds has spiked in recent months, averaging a post-crisis high of 31 basis points so far in 2017. The primary driver of this relative value boost has been a change in investor preference in favor of government money market funds after the implementation of US money market fund reform in October 2016. Prime funds suffered significant outflows in 2016, largely due to investor concerns over new liquidity fees and redemption gate rules and, for the first time, transacting at a fluctuating net asset value (FNAV). The resulting supply/demand imbalance -- excess demand for government money market securities and reduced demand for prime money market securities like commercial paper and certificates of deposit -- resulted in higher relative yields on prime money market funds."
Invesco notes, "However, since reform was implemented, fears over fees and gates have been largely unrealized and fluctuations of NAVs on prime funds have been minimal, in our opinion. Moreover, we believe higher relative yield levels on prime funds versus government funds can potentially compensate institutional investors for the risk of transacting at a floating net asset value. Wider spread levels of prime funds can reduce the breakeven holding period required to offset each $0.0001 decline in net asset value."
The piece adds, "It seems investors have taken notice of these developments and have gradually returned to prime funds. Total assets in these funds jumped by 49% to USD183 billion as of Sept. 26, 2017, after falling to an almost 20-year low of USD123 billion on Nov. 8, 2016 immediately following US money market fund reform."
They conclude, "Looking ahead, we believe yields on prime funds could continue to increase in the months and years ahead if the Fed stays on its current path of removing of monetary policy accommodation. The relative value advantage of prime funds could also remain elevated if investor preference for government funds remains strong and supply/demand imbalances in the market for money market securities persist. Over the longer term, the relative spread could gradually adjust downward as investors take advantage of this renewed opportunity, but we expect it to remain relatively attractive in the near term."
In related news, Capital Advisors' latest report tells us, "In the year since the SEC instituted new rules governing money market mutual funds, institutional prime funds have recaptured some lost ground, although balances still lag government funds. Fund characteristics returned to pre-reform levels with wide dispersions and concentrated exposures to non-US financial issuers. Asset-backed instruments also increased. While prime fund yields benefitted from higher fed funds rates, the current prime-to government yield spread may be insufficient to bring back most investors."
They explain, "We think that structural changes have reduced prime funds' appeal to a subset of previous shareholders, with their main utility changed from overnight, stable value deposit equivalents to return-oriented reserve instruments. We are optimistic that prime assets will continue to grow, but are likely to be in the shadow of government funds for some time. Investors with slightly longer time horizons and tolerance for interest rate volatility may consider portfolios of separately managed securities as suitable alternatives."
The introduction says, "As the regulatory dust settled and the yield environment improved, there have been signs of awakened interest in institutional prime funds. In fact, group assets increased 45% between October 31, 2016 and October 31, 2017. The addition of approximately $56 billion outpaced the decline of $33 billion in institutional government funds over the same period. At the one-year anniversary of the SEC regulatory changeover, we take a metaphorical temperature on institutional prime funds and look for insight into their growth potential."
The CAG report continues, "As widely reported, shareholder preferences and fund family decisions resulted in uneven asset losses among prime funds. While fund families continue to woo institutional investors back to prime, concentration among industry players and shareholder concentration within funds appear to have worsened.... Due to uneven asset outflows, however, the top five families' collective market share rose from 57% to 64% and 79% as a percentage of overall institutional prime during the same time period.... [R]educed fund sizes also limit shareholder participation by institutional cash investors with large balances, particularly those who intend not to exceed 5% of any fund. Shareholder level information, unfortunately, is not available to the public which continues to present challenges for investors attempting to ascertain shared liquidity risk."
It explains, "To gain a broader understanding of institutional prime fund performance over government funds, we look to Crane Data's money fund indices. [I]nstitutional prime funds in the Crane Data universe earned 0.97% on average as of September 30, while institutional government funds earned 0.76%, for a yield spread of 0.21%. The prime over government spread has been 0.20-0.25% since December 2016. Past surveys conducted by treasury management associations and securities firms suggested a wide range of 0.25-1.00% yield spread for investors considering prime funds to overcome the obstacles of floating NAVs and redemption restrictions. Is the current spread enticing enough, in absolute terms and relative to government funds and the RRP, for institutional cash investors to take a serious look? Answers to this question vary from organization to organization, but we have noticed an uptick in investor inquires in recent weeks. The year-to-date increases in institutional prime assets also corroborated some reawakened interest in prime funds."
Finally, Capital Advisors comments, "We think that, although institutional prime funds have made impressive strides recovering from last year’s reform impact, structural changes have reduced their appeal to a subset of previous shareholders. Floating NAVs, uncertainty related to fees and gates and sponsor and shareholder concentration have changed the funds’ utility from overnight, stable value deposit equivalents to return-oriented reserve instruments. The multi-NAV pricing and redemption model with some prime funds is still untested in a volatile, rapidly developing intra-day market. We are optimistic that institutional prime fund assets will continue to grow, as the SEC’s 2a-7 rules governing MMFs continue to offer cautiously interested investors better protection and safeguards than ultra-short bond funds and private liquidity funds. Their more specialized appeal, however, may limit their long-term growth potential relative to government funds."
