Federated Investors, which announced the acquisition of PNC's money market fund assets earlier this month, recently hosted a webinar entitled, "2019: Liquidity Gets Back to Work," which featured Money Market CIO Deborah Cunningham. She discussed recent asset flows and the return to Prime MMFs, ESG issues and acquisitions in the money fund space. Cunningham tells us, "We're still excited [by] the fact that news articles are being generated around the liquidity space, keeping it front and center with investors.... Certainly from a 'cash is king' perspective, there's nothing that's really changed there in our opinion. The yields continue to be very, very attractive on our money market products, especially compared to deposit rates in the marketplace. Money funds are quite a compelling story, we think [this] will likely continue."
She comments, "ESG is something that has been first and foremost in Federated's mind since our majority owned acquisition of the Hermes Investment Management Company out of the U.K., which occurred in July of last year.... What has subsequently been the process, whereby we are methodically and very painstakingly implementing and integrating the various ESG insights that we're privy to through that ... acquisition. So integrating that into the credit process for our liquidity portfolios has been at the top of the list."
Cunningham continues, "So how does it look from a yield perspective? Again, cash is king once again in the context of steadiness and outperformance ... [vs.] other types of short-term rates and of inflation. The Fed pause and 'patience' that has caused the yield curve to flatten somewhat, and in some cases to invert, has been certainly a different set of market circumstances to deal with in the first [and] second quarter of 2019.... Today when you look at the 10-year it's down to 2.39 and the 2-year is at a 2.18. So it's quite a compelling story when you look at government money market funds and their gross yields being 2.45%, prime money market funds with their gross yields being 2.65%. When you compare those to 10's and 2's, you're not getting anywhere close to that for the much longer duration risk that you're taking in longer Treasuries. So this is again a story that continues to be compelling for those in search of a place to put their cash in the current marketplace. Money market funds are the recipients."
She comments, "You've got industry assets for prime portfolios growing 38%, whereby Federated's own prime portfolios grew by 49%. So a pretty substantial increase across both Federated, as well as the industry. And it's not in a single asset type either -- both our Prime institutional as well as our Prime retail products are growing. From an industry perspective, you see the numbers, Prime Institutional grew by 28% in the first quarter, Prime Retail by 46%. Federated's numbers were similarly aligned but higher in order to produce that overall prime increase of 49% for Federated. Industry government assets showed an increase of 1% over the year ending 3/31, whereas Federated government assets were up by 9%. Finally … industry assets for tax free money market fund assets being up 4% with Federated more than 10 times better that at 38%."
Cunningham says about ESG, "I can definitely say that the Hermes integration is one that is ongoing and probably will continue to be the case as we continue to progress down the path with our liquidity portfolios in 2019 and into 2020. What we are doing is leveraging the expertise that we have purchased with that acquisition; we are not recreating the wheel. We are using the information that we receive through the Hermes ESG engagement process through our credit process. So integrating it through our credit process in order to enhance what the outlook or the outcome of [our] 1 through 5 credit rating scale that we have internally, might reflect. So normally, if you look at various outside sources of E, S, and G information, Morningstar provides some input. Sustainalytics is another company that we use. There's public ESG data sources from corporations themselves FASB, MSCI ... all of those are external sources."
She explains, "However with the engagement aspect that occurs through the Hermes team, we are able to have a set of statistics and information and qualitative assessments that are proprietary from a Hermes and now a Federated perspective. As I said, we are continuing to integrate that into our credit research process.... We're not redoing what they're doing. We are using it in the context of our credit research function from a qualitative assessment perspective and then leveraging that into our 1 through 5 credit rating scale."
Cunningham adds, "What effectively though is not a black and white type of picture, is how we use that information. So it may be that we are very comfortable using lower rated issuers, if you will, from an ESG scoring perspective, as long as the directional change for those issuers in positive and the engagement that we've had with them from an analyst perspective is showing progress. That may be a better situation from our perspective than some company that might have ranked higher on the ESG scoring price process initially, but has been trending in a downward direction with what I call more negative comments from an engagement perspective. So it's not always necessarily reflective of a raw score, but rather directional change and essentially understanding how the qualitative aspects of the environmental, social, and governance process fits in with the quantitative and managerial assessment processes that we have always conducted through our Federated credit process."
When asked about their Private Prime Liquidity product, Cunningham responds, "We did pass through an asset threshold or milestone. As of May 6, we were at $1.1 billion, and we're continuing to grow from a diversification of client perspective. We've had good steady growth across a diverse set of underlying participants, including universities, corporations [and] broker dealers' cash.... Securitizations [also] are putting cash into the product on a regular basis and then at a point in time when needed taking it back out."
She adds, "The overall yield for this product stands today on a gross basis about a 2.55 that this is showing that yields as of May 6 on a 7-day basis of 2.53 on a 30-day basis of 2.51. It is continuing to be triple-A rated, very diverse from a standpoint of underlying security selection. We're usually about 25 to 35% in asset-backed commercial paper, similarly situated with regard to repurchase agreements. And then the remaining third or so of the portfolio is generally in some sort of bank instruments.... So what we've produced is a yield that's competitive, with other types of liquidity products with a very low risk high quality asset base."
When asked about Brexit, she answers, "From a Brexit perspective, we continue to use U.K. sovereign as well as U.K. banks. We have shortened our maturities on some of them, just to be reflective of what we think is a little bit riskier situation. But we continue to use them.... They're U.K.-domiciled, but these are global banks. We do not feel that any type of a Brexit scenario, whether it's a soft Brexit [or] hard Brexit, will have a detrimental influence on them."
Cunningham adds, "As far as the broader global issuers that we are using, we use ... banks in large domiciles that are double and triple-A rated for the most part. We continue to explore various ... Asian countries at this point, but ... our highest quality portfolios [continue] to be invested only in ... a couple of Japanese bank, and a couple of Australian banks. Canadian banks are probably one of our largest exposures. French banks are also quite large from a European perspective. Again, the key theme would be that these are not single country banks, these are large global banks and world banks, and as such and we continue to feel very comfortable that even in a slowing world economy they will continue to perform very well."
Another question on the call asked about the drivers of growth in prime funds. Is it yields spreads, retail vs institutional, NAV stability or the track record? Cunningham replied, "All of the above. That's the easiest answer. We are seeing flows into both institutional as well as retail products. Probably more retail in the 2018 timeframe, 2019 has been kind of a 50/50 split, retail and institutional. But [there are] definitely strong flows in both aspects of the business."
She tells us, "I go back to pre-reform of 2016, many of our clients did not have to, for regulatory reasons, leave Prime funds. They chose to leave Prime funds because they didn't know what to expect, they didn't know how much an NAV would fluctuate, they didn't know if there was really a potential for gates and fees. They just didn't know what the new product design would look like and that's why they chose to leave and they weren't alone. Most of their competitors, most of their peers did the same thing. Now that the spread of 20 basis points or so between prime and government has been locked in pretty tightly for the last several quarters, and they have not seen a huge amount of fluctuation from an NAV standpoint, they've not seen anyone get anywhere close to those liquidity gates and fees, I think they've decided that with incremental new cash flow it's a good place to try."
Cunningham also comments, "They're now putting all their cashflow in there and really not taking it out of government funds. It's coming from new sources, and I'd say some of those sources are the deposit market ... especially in the retail space [where] they're getting rates of 40 or 50 basis points. They'd much rather go into a fund that's giving them something that's north of 2 percent, without any kind of stipulation ... as to when they can withdraw that cash. So, they might not put all of it into the Prime fund, they might put a portion in the Govy's as well. But it's certainly ... at the forefront of most people's minds at this point that the diversification into that sector is a good one."
Finally, she was also asked about the PNC merger. Cunningham says, "Well, I'll just give you a quick recount of Federated's activities. We've done over 60 roll ups and acquisitions over the course the last 10 years or so, so it's not something that's new to us. We're always looking at clients that we deal with on a regular basis that necessarily don't want to be in this particular business anymore. In this case, our neighbors down the street at PNC Financial, we'd been working with them for a period of time and [it] fit the bill. The product that will be coming over from PNC in particular will go into our Government funds, Government Obligations fund, Treasury Obligations Fund, and USTCR [US Treasury Cash Reserves]. And that acquisition will be completed likely early in the fourth quarter with really no fanfare or no notification or differences that will be seen from an investor or shareholder base."
