Last week, we hosted "Crane's Money Fund Webinar: Portfolio Manager Perspectives, which featured Federated Hermes' Sue Hill, Northern Trust Asset Management's Peter Yi and UBS Asset Management's David Walczak. The three senior PMs discussed money market supply, asset flows, yields and the outlook for Prime money market funds, among other things. We excerpt from the first half of the webinar below. (Watch for more quotes next week, click here to access the recording and click here for our Webinar page.)
Hill comments, "Pete asked me to mark in a couple of high points related to the government market. I don't want to repeat everything that's happened. We all have lived through this, and we all know that in March there were enormous inflows of assets at a very rapid pace into government money market funds. We know the massive Fed actions across the board to support the market, support functioning, market liquidity. We know there's been massive fiscal support as a result to address the impact of the coronavirus and the shutdown."
She continues, "Government funds absorbed the inflows relatively well. Initially in March, through issuance on the agency side, Federal Home Loan banks in particular [supported the] growth. As we flipped the calendar into April and May, [we saw] substantial issuance, at a pace never seen before, of Treasury bills, through regular Treasury bill issuance and cash management bills. So we got through that time period reasonably well. That issuance by Treasury removes that threat of negative rates in the secondary market that we saw in late March and into early April. It was also aided by the fact that the Fed started to pull back a little bit on their Treasury and agency purchases in that time as well."
Hill asks, "What happens to the Treasury supply going forward? We’ve seen cutbacks already.... I don't for a minute worry about having enough to buy, I just worry about what the rates will be if cutbacks continue.... The second question we have is, 'What happens to government money market assets going forward?' We've obviously seen some declines. Recently, the inflows came from a variety of sources. And there's nothing that's particularly clear, and no defining moments that I think will make it all leave. But we do have to plan accordingly."
Walczak tells us, "Through the March period, we did see quite a bit of volatility as it relates to flows of the various money market funds…. Obviously, Prime was the one that was the most impacted to the downside. The industry overall needed to ensure that we had adequate liquidity to facilitate the outflows, which I think was aided by the Fed's various programs. In particular, the MMLF … provided a good lifeline to Prime funds in order to again allow them to facilitate outflows and raise liquidity. Since then, we've seen a pretty substantial rebound in assets.... I think for investors looking to capture additional yield, that proved to be pretty attractive and led to the rebound that we saw in assets."
Asked about yields, he answers, "It's pretty amazing thinking back to where we were in March, just how quickly yields have snapped back and spreads have come in. To put it in a little bit of context.... [W]e're required to hold a certain amount in our prime funds in weekly liquidity, the minimum being 30%. Ourselves, and many of our peers, I think, strive for 40 to 50%, so maybe even a little bit higher. But generally, the instruments that comprise that bucket are going to be overnight repo, which right now can be anywhere between eight to 10 basis points, and then also, one-week commercial paper and CDs as well. Then interestingly, one thing that we've done in recent weeks, and we've seen other prime fund do this as well, is satisfy the weekly and daily liquidity buckets with Treasury holdings."
Walczak adds, "As you move further out the curve, certainly we've seen the yield compression. We see where three-month Libor is trading, 25, 26 basis points. I would say some issuers are definitely getting down much lower than that, kind of in the context of 22, 23, 24 basis points. So, it is very compressed. Even as you go further out the curve, you kind of struggle to get anywhere north of even 30 to 35 basis points. So, Prime fund yields as you look at them today, I think you've seen them start to come in. And just given some of the yield levels that I quoted, I would expect the yields on Prime funds to continue to decline. But still, they [have] spread [over] Treasuries so I think that differential will still be there going forward as well."
Discussing flows, Yi says, "The industry is up about 28%, or about $1 trillion year-to-date. Northern Trust, it certainly got its fair share … even more than its fair share. We're up roughly around 66%.... At least in our money market mutual funds, and we’re up pretty significantly across our entire liquidity franchise. We think a lot of that will stick around for a while as institutions grab all the liquidity they can just to strengthen their balance sheets and retail investors look for a little more stability in their asset allocation. For us, it's all about just kind of continuing to stick to our strategy. A lot of that centers around our interest rate views and really opportunistically implementing the duration levers in a meaningful way when we can. Sometimes we just have to be patient and be nimble enough just to jump in when we find some favorable technicals for these small openings."
He continues, "With regard to Northern's exit from Prime ... even though, before for the money market meltdown in March, it was something we were already debating, the coronavirus just kind of made the decision easy for us. The bottom line is, the current structure of institutional prime money market funds is just simply not that desirable for the majority of our investors. And, for all those that seek that type of credit strategy, we’re without a doubt still committed to offering them solutions through a variety of comparable, and even sometimes better solutions, like SMAs, offshore cash funds … even products that really provide a better risk reward balance in high quality investment grade products … like conservative ultra-shorts or even ETFs."
Yi explains, "When you think about everything that happened during that March Madness, it's clear it was a very unpleasant experience for everyone. For portfolio managers looking to liquidity, fund sponsors just watching their dashboards flashing red, regulators were looking for tools to stabilize the markets. But, most importantly, without a doubt, our investors just had an incredibly unpleasant experience as well. There were Institutional Prime investors that just feared if they didn't leave first … that left them stressed out to quickly shift into government funds first. Then the remaining investors started to panic and fear liquidity profiles just becoming too weak. So, nobody likes this dynamic."
He adds, "But, as you know, this is the way we're kind of connecting the dots on the future of the industry. We think there's a very good chance that Prime funds could look dramatically different when there is a reassessment potentially for money market reform. The reality is, the Fed had to step in to support the market, even though they're really there for all the markets as well. But, what little people know is that there was so much concern around our industry at that time, that in … the CARES Act Secretary Mnuchin actually snuck in a provision that would allow the U.S. Treasury to backstop the money market industry again, after it was explicitly prohibited following the Great Financial Crisis."
Finally, he states, "As we enter another prolonged cycle where interest rates are going to be anchored at zero, the credit spread compression, that I think Dave touched on earlier, is going to clearly favor the government's strategy because you just won't be paid for the credit risk right now. You know, all strategies may end up yielding between zero and a couple basis points. And I just can't see the catalyst for the Prime sector to grow anytime soon."
But Walczak counters, "Around our views on prime, yeah, we're still committed to the business. I think we still feel that our shareholders find value in the product. You know, point taken from Peter in terms of the spread compression. But I think we can also point to the period after the Great Financial Crisis and how we did still see assets hanging around in Prime funds."
He adds, "I think what will be interesting is, obviously we've seen other liquidity management options, such as ultra-short funds grow in recent years. So now I think investors have much more choice as it relates to their liquidity management program and approach. So, perhaps, we do see some assets that flow in that direction as well. But, we're still of the opinion that, again, it does serve a purpose as part of an overall liquidity management program."
