Wells Fargo Asset Management posted a recording entitled, "Money market funds: An update post the COVID-19 market shock," which featured Laurie King interviewing Jeff Weaver, Head of Money Funds and Short Duration Strategies. He tells us, "[In] March as fears of COVID-19 gripped the market ... there was a tremendous flight to quality in liquidity as investors sold risky assets and flooded the market in pursuit of cash positions [and] there was a tremendous amount of cash that made their way towards money market funds. In the month of March alone, $790 billion flowed into government and treasury money market funds. At the same time, $160 billion came out of prime money market funds as they were perceived to be more risky."
When asked about "Federal Reserve policy responses being implemented," Weaver answers, "That has certainly come with a number of programs and we've written about them on our blog and our portfolio manager commentary from the money market fund team. Before I highlight the one program that was really crucial for money market funds, and that being the Money Market Liquidity Facility or MMLF, I thought it's important that I should set the stage and provide some background for prime money market funds in particular."
He explains, "SEC Rule 2a-7 requires that money market mutual funds maintain 10% in daily liquidity and 30% in weekly liquidity. So fund managers typically maintain liquidity but beyond these requirements with most funds having been about 40% in weekly liquidity or more. And what we saw in the month of March is as prime redemptions grew, fund managers were being forced to sell longer assets in order to maintain these liquidity requirements. Unfortunately, these sellers were met with a tremendously illiquid bond market and bid on these high quality, typically very liquid securities were at best highly distressed or in many cases, nonexistent. So, as prime fund redemptions accelerated, the Fed smartly instituted the MMLF on Wednesday, March 18 at Midnight Eastern Time in order to provide liquidity to prime and to a lesser extent, municipal money market funds, and to begin to repair the dysfunctional short-term credit markets."
Weaver continues, "Whereas some of the Fed's programs' effectiveness were questionable, the MMLF certainly hit the mark. MMLF-eligible assets include domestic commercial paper, asset-backed commercial paper, certificates of deposit, and municipal securities, including VRDNs. Also eligible were floating rate structures and Yankee CDs, which are CDs issued by U.S. branches of foreign banks. These are all assets that are widely held by prime funds. The facility allowed for prime and municipal money market funds to sell these eligible securities to broker-dealers at amortized cost while those broker-dealers were able to have those purchases financed by the Fed at a rate of prime +100 basis points, or 1.25%."
He adds, "Once the facility was in place, prime funds were able to get the liquidity necessary to meet redemptions. Redemptions began to slow, and by the end of March and into April, those redemptions reversed and turned into additions as short-term markets began to repair and investors started to see value in prime money market fund yields."
King also asks, "How do you feel the short-term bond markets are working now?" Weaver responds, "Short-term bond markets are much better, but they have yet to completely normalize and be in a position to provide good two-way liquidity for market participants.... We believe the worst is certainly behind us and that the retracement of yield spreads are indicative of an improving market."
He says, "We've had to spend a lot of time over the past month reminding and educating investors about the money fund reforms that went into place on October of 2016. At that time, prime and municipal money market funds were split into those exclusively for retail investors and those for institutional investors. The reason these two investors were split was because institutional investor flows were not only larger, but typically much more volatile, particularly in times of stress. After reform, retail prime funds, limited to natural persons only, would continue to have a constant NAV of $1, just like government and treasury funds. However, going forward from that time on, institutional funds would have a floating NAV ... out to 4 decimals, so 1.0000 as a starting point."
Weaver tells us, "Additionally, for both retail and institutional funds, if the 30% weekly liquidity minimum mentioned earlier was breached, a funds board would have the choice whether or not to put in place a redemption gate, which would disallow withdrawals for up to 10 days, or liquidity fees, which would allow the fund to charge up to 2% for any withdrawals. Therefore, it became very important for fund managers to maintain a minimum of 30% liquidity."
He states, "In March, as market worries about COVID-19 increased and bond market illiquidity increased, institutional prime investors began redeeming their shares. These forces combined to cause floating NAVs on institutional prime funds to fall. Most NAVs across the industry fell 15 to 20 basis points or more over that period of time from a slight premium to 1 to a slight discount.... Since the MMLF was put in place and as redemptions turned to additions, most floating NAVs have increased off of their lows and are, in fact, moving back towards levels seen towards the end of last year. With the stabilization in NAVs, many investors are being attracted to the yield advantage of a prime fund versus a government fund."
Weaver comments, "During these volatile times, investors typically increase their cash position, and much of those cash positions find their way to the safety and liquidity of government and treasury money market funds. At Wells Fargo Asset Management, we have three government funds. The Wells Fargo Government Fund, which invests in treasuries, agencies, and repos secured by treasures and agencies. We have the Treasury Plus Fund, which invests in treasury securities and repos secured by treasuries. And then we have the 100% Treasury Fund, which solely invests in treasuries.... We've seen yields on these funds gravitate toward zero basis points. I think it's important to note that as fund yields trend toward zero, mutual funds begin to waive fees in order to maintain a yield of zero or 1 basis point."
He says, "Another thing that's come up in this environment is the fear of or the concern for negative interest rates. We do not believe that the Fed will employ a negative interest rate policy, but nonetheless, that does not keep treasury bills from trading negative when demand outstrips supply. Fortunately for government and treasury funds, with all the federal programs being put in place, the treasury is going to be increasing treasury supply by about $3 trillion, and about $1 trillion of that supply will be in treasury bills. So much of the pressure driving bill yields negative is now being relieved. And over the last two or three weeks, the increase in issuance of bills has moved bill yields from negative to positive."
Finally, King asks, "So what do you want investors to know about money market funds after the volatility in March?" Weaver answers, "During the month of March, we saw tremendous outflows from long-term muni bond funds, many of which invest their cash in VRDNs or municipal money market funds that invest predominantly in VRDNs. About $10 billion in outflows were witnessed from muni money market funds. Those are predominantly in VRDNs it ended up on dealer balance sheets.... SIFMA, which is the weekly rate that's indicative of variable-rate demand note yields, rose from 1.28% on March 11 to 5.2% on March 18. This provided an excellent opportunity for investors with excess liquidity. Because we increased our liquidity by so much in our prime funds from 40% to over 60%, we had a tremendous amount of cash that can be invested in a variety of securities. One of the places that we found opportunity was in VRDNs."
He adds, "Many clients are now becoming much less fearful as we get more and more information on COVID-19, as we witness a flattening of the curve, and as we begin to contemplate moving beyond the current shelter-in-place environment. We continue to see inflows into government money market funds, but we are also receiving increased inquiries and opportunities in prime and municipal money market funds, in addition to longer strategies in order to gain additional yield. Many conversations have changed to concerns about credit quality in short-term credit markets and concerns about downgrades by rating agencies as we enter into the slowdown in the economy. Nonetheless, our analysts and portfolio managers continue to be vigilant in purchasing high-quality assets across our money market complex and the objectives of providing liquidity and preserving capital continues to be at the top of our priorities."
