The February issue of Crane Data's new publication, Bond Fund Intelligence, which tracks the bond fund marketplace with a focus on the ultra-short and most conservative segments, interviews Leonard Aplet, Senior Portfolio Manager at `Columbia Management and a portfolio manager on Columbia's institutional CMG Ultra Short-Term Bond Fund, one of the largest and oldest conservative ultra-short bond funds. Aplet is responsible for Columbia's short duration strategies, a major segment of the manager's $20.7 billion in bond fund assets. We reprint the article below. (Watch for our profile of J.P. Morgan's Dave Martucci in the upcoming March issue of BFI. Contact us to subscribe or for a sample issue.)
BFI: How long have you been involved in the space? Aplet: I started at Columbia in 1987 and have managed money market funds and short term bond products ever since. The inception date of the Ultra Short Term Bond Fund is March 8, 2004, and the inception date for the Short Term Bond Fund is October 2, 1992. While each of the funds have named portfolio managers on them, there are research analysts, traders, and other portfolio managers that are all part of the team.... My group is a multi-sector group; we manage funds and separate accounts that typically invest in more than one investment grade sector. Columbia also has other fixed income teams that manage shorter duration assets that specialize in a single sector.
BFI: Why was the Ultra Short Term Bond Fund launched? Aplet: At the time Columbia launched the Ultra Short Term Bond Fund, we saw a gap in the market between money market funds and short duration. Our short duration bond fund has as a benchmark the Barclays 1-3 Government Credit Index, so we wanted something between zero duration and 1.5-1.75 years. It was a space that was filled with the Ultra Short Term Bond Fund. The current benchmark for that fund is the Barclays Short Term Government Corporate Index and it's basically anything that falls below the Barclays 1-3 year Government Credit Index. It's an institutional fund and one of the things we've been looking at in this marketplace is the need for a retail offering in the ultra-short term area.
BFI: What is the investment strategy? Aplet: As you know, money market funds are very restrictive and our money market funds are very plain vanilla. They're prime funds and we don't stray from the safe and stable. But with the Ultra Short Term Bond Fund, the difference is it can invest in securities that are longer, even though the overall duration of the Ultra Short Term Bond Fund is not that much longer than a money market fund. It has a duration of around 0.6 years and the benchmark is 0.55 years. The Fund can be as long as a year so it can be quite a bit longer than money market funds. In terms of the individual securities, we will typically go out as far as three years on an individual security basis. So the Fund can employ strategies like barbells when the yield curve is steeper. That's something that a money market fund cannot do. We also can invest in the full range of investment grade securities, down to triple-B. Typically, a money market fund that buys prime securities only buys A1-P1 securities. So we can go down a little bit lower in credit quality but still stay within the investment grade universe. We can also buy tranches of asset-backed securities that are beyond the 2a-7 limitations. Overall, we can be a little bit longer with individual securities; we can invest in some asset classes that are not 2a7 eligible; and we can go down to the full extent of investment grade credit.
BFI: What is the outlook for supply? Aplet: In general, there are not enough bonds to go around. That's not going to get any better going forward, as the population ages, the preference for bonds grows, and a large percentage of US Treasuries are owned by foreign governments, as well as by the Fed itself. So all of that has taken supply out of the market, not necessarily just at the short end of the curve, but it has taken general supply out of the marketplace. There has been good supply of corporate bonds over the past couple of years, but that supply has been met with even higher demand. So when new securities come to the marketplace, they are generally over-subscribed and you can't purchase as much as you want. That has, I think, contributed to less liquidity in the market today. We want to make sure that the NAV price of the fund doesn't fluctuate very much, that we have securities that maintain their investment grade credit rating, and that we provide the necessary liquidity so clients can withdraw their funds when they need them.
BFI: What are the key challenges? Aplet: The recent rally has affected the longer end of the yield curve more than the shorter end, so it hasn't really impacted our yields as much. The very short-term yields have actually gone up a little bit over the past several months, but yields are still low. That's something that is hard to accept for some investors so they go out searching for yield -- sometimes in the right places, but sometimes in the wrong places. Or it could be the right place today, but the wrong place as the market changes. One of the challenges that we see is that besides the fact that yields are low, investors' preferences for yield is growing, so investors are maybe taking more risk today than they would have been comfortable taking a few years ago. We think that has caused more demand for products that are lower quality, especially in the ultra-short term space. Despite that thirst for yield, however, we have stuck with our strategy to provide the investment grade products that our clients signed up for and I think that's going to keep us in good stead as we go through this cycle.
BFI: How are regulations impacting this space? Aplet: Money market reform regulations are going to have a major impact. We also have money market funds, so we're in the process of making decisions on institutional vs. retail; prime vs. government, etc. So far I don't think these changes have caused a tremendous amount of fund flows. You have seen a few mutual fund complexes announce changes to their funds, but in general, people haven't really made those announcements. We're trying to assess what clients find most important -- Is it the floating NAV? Is it the potential for a fee or gate? There's still some time before investors make decisions, so we are evaluating our lineup as we constantly do. Our product development team is looking at the different options to make sure we are giving clients a full range of offerings. We're not yet at the point of offering anything new, but it's something we're definitely considering.
BFI: Has the space been attracting assets? Aplet: The ultra-short term bond space saw most of the asset gains about one to two years ago as investors sought out yield and safety of principle. Much of the money in ultra-short funds came from money market funds or cash-type investments. It's not that big a leap in terms of risk, but I think a lot of that movement has already occurred. So that movement into ultra short funds probably peaked a year ago. However the flows may pick up again if investors decide to move more funds from either lower yielding money funds or longer duration bond funds.
BFI: What is your outlook for rates? Aplet: Our economists see the Fed potentially acting in the second half of the year. The Fed has allowed the unemployment rate to fall below the level that they originally were looking for to raise rates, but they did that because they knew the participation rate was low and the underemployment rate was still pretty high. Now that the adjusted unemployment rate is coming in at about the level in which they previously said they would start raising interest rates, I think they are a little bit more anxious to act. Our view is it's a second half 2015 phenomenon, but instead of June, it might be closer to the end of 2015 before the Fed acts.
BFI: And rising rates might not be a bad thing, right? Aplet: I think people lose track of the fact that rising interest rates are not the worst thing in the world for ultra-short term and short duration products. It's going to drive better returns, especially if you look at returns on a total return basis. The NAV can fall somewhat, but in the case of our products, they are short enough that they won't fall very much, yet the increase in yield is going to more than make up for that. So, our investors are going to be better off if interest rates rise, even if it may not seem like it at the time. When the Fed does start raising rates, the good thing is that ultra-short and short duration funds are probably going to be as much or more rate responsive than money market funds, because there's so much subsidy in the expense ratio for many of the money market funds, more than the longer duration funds. Some of that interest rate increase needs to be absorbed by a reduction in that subsidy. So if rates go up 25 basis points, will the net yield on money market funds go up 25 basis points? I doubt that will happen.
State Street Global Advisors hosted a webinar recently called, "The New World of Cash - Rate Hike Scenarios, which was moderated by SSgA's Head of the US Cash Business Yeng Butler, and featured Portfolio Strategist Will Goldthwait and Head of Global Cash Management Matt Steinaway. On interest rate hikes, Goldthwait said, "I'm taking a more hawkish view on Fed policy in the coming year. I believe that the Fed is going to raise interest rates or raise their target range, as Yeng described, at their June meeting. One thing that I'll be on the lookout for is when they drop the "patient" phrase in their FOMC minutes. I would expect at the March meeting we're going to see that "patient" word dropped, and that will lead to the June meeting for a Fed rate hike."
Steinaway discusses what cash investors should be looking out for this year. "There have been significant shifts resulting from regulatory activities, both around Dodd-Frank, Basel III and 2a-7 Money Fund Reform, but there have been substantial shifts in supply mechanisms and demand mechanisms in the liquidity markets. So we have seen within the supply mechanism in the market, we have seen a decreased issuance from banks, financial institutions, three months and in, and that does make it more challenging to manage a portfolio in a rising rate environment where you're trying to keep your weighted average maturities relatively short."
Steinaway continues, "The second issue, the shifting asset mix in the money fund universe, speaks directly to the 2a-7 money fund reform. We have seen the potential for, and in fact in some cases an announcement around the movement from prime money funds that do buy short-term paper, bank paper and repo and Treasury bills, into funds that only purchase Treasury bills. So, again, that is additional pressure on the front end, particularly in a high-quality Treasury space, where a lot of investors in a rising rate environment would normally seek short-duration, high-quality assets. It is our view that that shift will make those assets much more expensive, much more scarce. So we do think this cycle, this rising rate cycle, will be more challenging for cash managers as they enter the cycle because of the regulatory challenges in front of us."
In conclusion, Butler says, "I think we can conclude that the global market environment for cash has never been more challenging. The investment offerings that will be available to cash investors will be changing more in the next few years than they have in the past 20."
In other news, Fidelity Investments, which recently announced that it will convert 3 Prime retail MMFs to Government funds including the $112 billion Fidelity Cash Reserves (see our Feb 2 "News"), released a paper entitled, "Government Money Market Mutual Funds Remain an Attractive Option for Investors." Fidelity discusses supply, particularly in the government sector.
They write, "In the wake of MMF reforms, Fidelity expects the supply of government securities will continue to be sufficient to accommodate the potential growth in demand from investors choosing to move from floating-NAV prime funds to stable-NAV Treasury and government funds. The liquidity levels of these funds typically far exceed the minimum levels required by Rule 2a-7. Even those fund holdings that do not technically qualify as either daily liquid assets or weekly liquid assets generally exhibit favorable liquidity characteristics versus nongovernment securities. Government MMFs have offered competitive yields when compared with prime MMFs. For much of the period from January 1995 to today, the yield difference -- or spread -- between prime and government MMFs averaged about 0.06%, the exception being the two-year period spanning the financial crisis."
Finally, the Federal Reserve's latest semiannual Monetary Policy Report says prime money market funds could be vulnerable to investor runs. The report was covered by The Wall Street Journal in, "Fed Flags Concerns About Mutual Funds, Exchange-Traded Funds." There are a few passages related to money market funds, including one related to the vulnerability of prime money market funds and a recap of the Overnight RRP operations.
Under the section, "Developments Related to Financial Stability," the Fed report says, "Reliance on wholesale short-term funding by nonbank financial institutions has declined significantly in recent years and is low by historical standards. However, prime money market funds with a fixed net asset value remain vulnerable to investor runs if there is a fall in the market value of their assets. Furthermore, the growth of bond mutual funds and exchange-traded funds (ETFs) in recent years means that these funds now hold a much higher fraction of the available stock of relatively less liquid assets -- such as high yield corporate debt, bank loans, and international debt -- than they did before the financial crisis. As mutual funds and ETFs may appear to offer greater liquidity than the markets in which they transact, their growth heightens the potential for a forced sale in the underlying markets if some event were to trigger large volumes of redemptions."
Finally, under the subhead, "Additional Testing of Monetary Policy Tools," it states, "During policy normalization, the Federal Reserve also intends to use an overnight reverse repurchase agreement (ON RRP) facility and other supplementary tools -- including term reverse repurchase agreements (term RRPs) and term deposits offered through the Term Deposit Facility (TDF) -- as needed to help control the federal funds rate <b:>`_."
The Securities and Exchange Commission has begun publishing a monthly "Money Market Fund Statistics" report, which summarizes Form N-MFP data and which includes totals on assets, yields, liquidity, WAM, WAL, holdings, and other money market fund trends. The data is produced by the SEC's Division of Investment Management. This inaugural release includes data as of Dec. 31, 2014, but the Jan. 31, 2015 data should be available shortly. Overall, total money market fund assets stood at $3.081 trillion at the end of the year, up $27 billion from Dec. 31, 2013, according to the SEC's broad total (which includes many private and internal funds not reported to ICI, Crane Data or other reporting agencies). We review the SEC's summary below, and also excerpt from Chair Mary Jo White's recent comments on money funds and from Fed Chair Yellen's testimony Tuesday.
Of the $3.081 trillion, $1.772 trillion was in Prime funds (down $20B from Dec. 31, 2013), $1.038 was in Government/Treasury funds (up $57B), and $270 billion was in Tax-Exempt funds (down $11B). There was quite a bit of consolidation as well, as the number of funds dropped to 546 from 561 at year-end 2013 and 592 on Dec. 31, 2012. We plan to track this new aggregate data and compare it month-to-month going forward.
Looking at other statistics, the Weighted Average Gross 7-Day Yield for Prime Funds was 0.20% on Dec. 31, 0.08% for Government/Treasury funds, and 0.07% for Tax-Exempt funds. The Weighted Average Net Prime Yield was 0.05% and the Weighted Average Prime Expense Ratio was 0.15%. All these numbers were virtually the same a year ago when rounded. The Weighted Average Life, or WAL, for Prime funds at year-end was 76.6 days (down from 79.6 days on Dec. 31, 2013), for Government/Treasury funds was 74.9 days (up from 65.7), and for Tax Exempt funds was 37.2 days (up from 36.4 days). The Weighted Average Maturity, or WAM, for Prime funds was 42.8 days (up from 46.0), for Govt/Treasury funds was 43.5 days (down from 48.3), and for Tax-Exempt funds was 36.2 days (up from 35.3 days). Total Daily Liquidity for Prime funds was 22.5% (down from 23.9% at the end of 2013), while Total Weekly Liquidity was 41.3% (up from 37.3%).
In the category Prime MMF Holdings of Bank Related Securities by Country, the US topped the list with $209.8 billion, just ahead of Canada at $209.2 billion. Japan was third with $176.9 billion, followed by France $130.4, Australia/New Zealand at $99.7B, and the UK at $71.7B. The Netherlands ($58.2B), Switzerland ($48.6B), Germany ($37.4B), and Singapore ($24.7B) round out the top 10. For Prime MMF Holdings of Bank-Related Securities by Region, Europe had $462.7 billion in while its subset, the Eurozone, had $235.2. The Americas was next with $421.7 billion, while Asia and Pacific had $308.9 billion.
The Total Amortized Cost of Prime MMF Portfolios was $1.759 trillion as of Dec. 31, 2014, down from $1.774 trillion 12 months earlier. That was made up of $580 billion in CDs, $504 billion in Government (including direct and repo), $340 billion in Non-Financial CP and Other Short term Securities, $238 billion in Financial Company CP, and $97 billion in ABCP. Also, the Proportion of Non-Government Securities in All Taxable Funds was 44.8% at year-end, down from 45.7% at year-end 2013. Further, All MMF Repo with Federal Reserve was $371.1 billion on Dec. 31, 2014, up from $154.6 billion at the end of 2013. Finally, the Trend in Longer Maturity Securities in Prime MMFs said 41.6% were in maturities of 60 days and over, while 12.0% were in maturities of 180 days and over.
In other news, SEC Chair Mary Jo White at Friday's "SEC Speaks" conference, discussed money fund reform and the SEC's plans for 2015. Chair White said 2014 was "a year of significant accomplishment" for the agency, commenting, "In 2014, we also adopted a number of critical reforms to promote financial stability for the protection of investors and to strengthen our markets following the financial crisis, including reforms related to money market funds, over-the-counter derivatives, asset-backed securities and credit rating agencies."
On MMF reform, she said, "U.S. money market funds, which hold more than $3 trillion, are critical to investors, corporations, municipalities and the overall economy. The crisis sparked important concerns about the operation of money market funds, particularly in times of stress. Following an extensive and careful analysis, the Commission, in July, adopted final rules that will fundamentally change the way these funds operate.... This was a very significant and important accomplishment for the agency and our staff will continue to carefully monitor market adjustments to the new reforms as they are fully implemented in 2016."
Commenting on what's ahead, White said, "Our post-crisis focus needs to include, among other things, particular attention to the activities of asset managers. As I outlined in remarks in December, the staff has been developing three sets of initial recommendations to address the increasingly complex portfolio composition and operations of today's asset management industry, which manages more than $62 trillion of assets.... The first seeks to modernize and enhance data reporting for both funds and investment advisers. The second would require registered funds to have controls in place to more effectively identify and manage the risks related to the diverse composition of their portfolios, including liquidity management and the use of derivatives in mutual funds and ETFs. The third focuses on planning for the impact of market stress events or when an adviser is no longer able to serve its clients."
Finally, Federal Reserve Board Chair Janet Yellen testified before Congress yesterday, providing some details on what "patient" means and the mechanics of rate hikes moving forward. Yellen said, "The FOMC is also providing forward guidance that offers information about our policy outlook and expectations for the future path of the federal funds rate. In that regard, the Committee judged, in December and January, that it can be patient in beginning to raise the federal funds rate.... The FOMC's assessment that it can be patient in beginning to normalize policy means that the Committee considers it unlikely that economic conditions will warrant an increase in the target range for the federal funds rate for at least the next couple of FOMC meetings. If economic conditions continue to improve, as the Committee anticipates, the Committee will at some point begin considering an increase in the target range for the federal funds rate on a meeting-by-meeting basis. Before then, the Committee will change its forward guidance. However, it is important to emphasize that a modification of the forward guidance should not be read as indicating that the Committee will necessarily increase the target range in a couple of meetings."
Yellen added, "Let me now turn to the mechanics of how we intend to normalize the stance and conduct of monetary policy when a decision is eventually made to raise the target range for the federal funds rate... The FOMC intends to adjust the stance of monetary policy during normalization primarily by changing its target range for the federal funds rate and not by actively managing the Federal Reserve's balance sheet. The Committee is confident that it has the tools it needs to raise short-term interest rates when it becomes appropriate to do so and to maintain reasonable control of the level of short-term interest rates as policy continues to firm thereafter, even though the level of reserves held by depository institutions is likely to diminish only gradually. The primary means of raising the federal funds rate will be to increase the rate of interest paid on excess reserves. The Committee also will use an overnight reverse repurchase agreement facility and other supplementary tools as needed to help control the federal funds rate. As economic and financial conditions evolve, the Committee will phase out these supplementary tools when they are no longer needed."
Federated Investors, which last week announced reform strategies and changes to its money fund lineup (see our Feb. 20 News), also detailed risks and plans in its latest "10-K" Report with the SEC Friday. The filing revealed a 6% drop in money market fund assets to $258.8 billion at year's end. Overall, as of December 31, 2014, Federated managed $362.9 billion in assets, down 4% for the year. Money market funds were by far the largest segment of their asset base, or 71.3% of total assets. Of the total money market fund assets, $225.5 billion were in MMFs (down 6% for the year), and $33.3 billion were in separate accounts (down 7%). Federated managed money market assets in the following asset classes: government ($126.0 billion); prime ($105.1 billion); tax-free ($18.4 billion); and non-U.S. domiciled ($9.3 billion). Federated's investment products and strategies are primarily distributed in four markets: wealth management and trust (44%), broker/dealer (34%), institutional (19%) and international (3%). In the report, Federated also discussed the impact of fee waivers on revenues, and how it plans to adapt to MMF reforms with new 60-day MMFs.
The report discusses further the impact of the SEC's MMF reforms. "Management believes that the floating NAV will be detrimental to Federated's money market fund business and could materially and adversely affect Federated's business, results of operations, financial condition and/or cash flows.... Federated also is reallocating resources to plan and begin implementation of product development and restructuring initiatives in response to the 2014 Rules. While Federated's plans are not finalized and continue to evolve, and remain subject to fund board, and in certain cases, fund shareholder and other, review and approvals, Federated anticipates taking steps to adjust its product line to address the liquidity management needs of a broad array of customers."
The 10-K explains, "Such steps will include, for example, conducting shareholder votes to seek approval of changes to the organizational or governing documents of certain Federated Funds, such as Money Market Obligations Trust, the registrant for the majority of Federated's money market funds, proposing to modify, add share classes to or reorganize certain existing Federated Funds, and developing new products and strategies. Federated anticipates that the adjustments to Federated's product line will offer investors a full menu of product choices for liquidity management. For example, Federated will continue to offer Treasury and government money market funds, and will designate existing prime and municipal money market funds as either institutional or retail funds. Federated's Treasury and government money market funds will continue to seek a $1.00 NAV per share."
It continues, "Regarding retail money market funds, Federated plans to offer prime money market funds, national municipal money market funds, state-specific municipal money market funds, and variable annuity money market funds. Federated's retail money market funds will continue to seek to maintain an NAV of $1.00 per share. Regarding institutional money market funds, Federated plans to offer prime money market funds and national municipal money market funds. Regarding institutional prime and municipal money market funds, Federated anticipates converting certain existing Federated Funds to 60-day maximum maturity funds while other existing funds will remain 397-day maximum maturity funds."
On the 60-day maximum maturity funds, it says, "Federated anticipates that institutional prime and municipal funds selected to be 60-day maximum funds will begin to gradually limit their investments in late 2015 to securities maturing on or before December 14, 2016, which is 60 days post implementation, so that the funds can be restructured appropriately by the final mandatory compliance date for the 2014 Rules in October 2016. Each time a 60-day maximum fund calculates its NAV per share, it will use amortized cost to value its portfolio securities as long as there are no market quotations available and each such security's amortized cost approximates the security's fair value."
Federated's 10-K continues, "Beginning on or about the final mandatory compliance date for the 2014 Rules in October 2016, the 60-day maximum funds will attempt to maintain an NAV of $1.0000 per share and, under ordinary circumstances, the funds' per share price would be expected to experience little or no fluctuations.... Federated believes that the short maturity of the securities held by these funds should help to limit the instances when these events may cause a fund's $1.0000 NAV per share to change."
It adds, "Federated also anticipates that on or about the final compliance date for the 2014 Rules in October 2016 Federated will convert at least one Federated Fund to a floating NAV money market fund for customers seeking an institutional prime money market fund with potentially higher yields than the 60-day maximum money market funds. Federated also continues to explore investment strategies as investment options for certain customers and the feasibility of private funds that mirror existing Federated money market funds as investment options for qualified investors."
The report also comments on possible Financial Stability Oversight Council regulations. "FSOC may recommend new or heightened regulation for "nonbank financial companies" under Section 120 of the Dodd-Frank Act, which the Board of Governors of the Federal Reserve System (Governors) have indicated can include open-end investment companies, such as money market funds and other mutual funds. Management respectfully disagrees with this position. On December 18, 2014, FSOC published a Notice Seeking Comment on Asset Management Products and Activities seeking public comment on aspects of the asset management industry, including whether asset management products and activities may pose potential risks to the U.S. financial system in the areas of liquidity and redemptions, leverage, operational functions and the failure or closure of an asset manager or investment vehicle. (Comments are due by March 25, 2015.) Federated, individually and together with mutual fund industry groups, is participating in the public comment process. Management does not believe that asset managers and management products, such as money market funds, create systemic risk requiring regulation by the Governors and/or FSOC."
Concerning fee waivers, they explain, "Since the fourth quarter of 2008, Federated has voluntarily waived fees (either through fee waivers or reimbursements or assumptions of expenses) in order for certain money market funds to maintain positive or zero net yields. These fee waivers have been partially offset by related reductions in distribution expense and net income attributable to non-controlling interests as a result of Federated's mutual understanding and agreement with third-party intermediaries to share the impact of the waivers.... With regard to asset mix, changes in the relative amount of money market fund assets in prime and government money market funds as well as the mix among certain share classes that vary in pricing structure will impact the level of fee waivers. Generally, prime money market funds waive less than government money market funds as a result of higher gross yields on the underlying investments. Assuming asset levels and mix remain constant and based on recent market conditions, fee waivers for the first quarter of 2015 may result in a negative pre-tax impact on income of approximately $28 million, which is slightly less than the impact to each quarter included in 2014."
Finally, the report says, "Federated continues to explore opportunities to further expand its global footprint. In 2014, among other initiatives, Federated focused on growing distribution opportunities for its products and services in Canada and Latin America. In 2014, Federated also continued to seek acquisition candidates, both internationally and domestically."
Late Friday, J.P. Morgan Asset Management, the largest manager of money market funds globally, published a press release entitled, "JPMorgan Money Market Funds Announce Intended Money Market Fund Designations In Response To SEC Reforms." It says, "J.P. Morgan Asset Management today announced that the Board of Trustees of the JPMorgan Money Market Funds approved the firm's preliminary recommendation regarding the intended designation of its publicly offered money market funds as "Institutional," "Retail" or "Government," in accordance with the criteria established by the Securities and Exchange Commission ("SEC") in July 2014. These determinations were reflected in a supplement to the money market funds' registration statements filed today. In the supplement, the Board also stated that it has no current intention of instituting liquidity fees or gates on the money market funds ("MMFs") designated as Government MMFs."
John Donohue, Head of Global Liquidity for J.P. Morgan Asset Management, comments, "The new rules include several significant structural changes. We are committed to providing shareholders with as much clarity and information as we can. We recognize that shareholders -- retail intermediaries, in particular -- need as much time as possible to adjust to these changes. As an industry leader, we look forward to continuing to meet investors' liquidity management needs in new and innovative ways."
Donohue adds, "We also want to reiterate that our MMFs' board has no current intention of utilizing fees and gates in our Government MMFs. Additionally, investors should know that our board does not currently plan to institute a floating net asset value ("NAV") in our Prime MMF, and fees and gates in our non-Government MMFs any sooner than the second half of 2016."
J.P. Morgan's statement lists "Funds seeking Retail qualification" as: JPMorgan Liquid Assets Money Market Fund, JPMorgan Tax Free Money Market Fund, JPMorgan California Money Market Fund, JPMorgan New York Municipal Money Market Fund, and JPMorgan Municipal Money Market Fund. "Funds seeking Government qualification" include: JPMorgan 100% U.S. Treasury Securities Money Market Fund, JPMorgan Federal Money Market Fund, JPMorgan U.S. Government Money Market Fund, and JPMorgan U.S. Treasury Plus Money Market Fund. Finally, "Institutional Prime" funds will include: JPMorgan Prime Money Market Fund, currently the 3rd largest MMF Portfolio (behind Vanguard Prime and Fidelity Cash Reserves) with $112 billion.
The release explains, "Under the recent amendments to the SEC rules that govern the operation of registered MMFs, those that qualify as "Retail" or "Government" will be permitted to continue to utilize amortized cost to value their portfolio securities and to transact at their existing $1.00 share price, as currently permitted. The JPMorgan Prime MMF, which will not qualify as "Retail" or "Government," will be required to price and transact in its shares at NAVs reflecting current market-based values of its portfolio securities (i.e., at a "floating NAV"). The floating NAV will need to be rounded to four decimal places for a MMF with a $1.00 NAV (e.g., $1.0000)."
It continues, "Additionally, each non-Government MMF must adopt policies and procedures to be able to impose liquidity fees on redemptions and/or redemption gates in the event that its weekly liquid assets were to fall below a designated threshold, subject to the actions of the MMF's board. Though compliance with these amended rules is not required until October 2016, the JPMorgan MMFs are providing these preliminary plans early in response to investor demand and to help ease the transition to new rules by allowing investors to plan their future investments."
Finally, JPMAM adds, "It is currently anticipated that the Board will consider both (i) the date of the transition of the JPMorgan Prime MMF to a floating NAV and (ii) the date after which the Board may consider the use of liquidity fees and gates for non-Government MMFs during the second half 2016 and that such changes will occur on, or prior to, October 14, 2016. Additionally, the retail MMFs and government MMFs will seek to meet the applicable new SEC requirements on, or prior to, October 14, 2016."
J.P. Morgan becomes the first money fund manager to designate which of its funds will be "Retail", "Institutional" or "Government". Earlier this month, Fidelity Investments announced that it was changing its flagship retail Fidelity Cash Reserves into a Government fund. (See our Feb. 2 News, "Fidelity Announces Major Changes to MMFs; Staying Stable, Going Govt".) And Thursday, Federated Investors published a press release detailing its preliminary reorganization plans. (See our Feb. 20 News, "Federated Announces Changes; Targets Floating MMFs That Won't Float".)
Federated Investors, the 4th largest money fund manager with $210.6 billion, became the second major player to officially announce plans to restructure its money market fund lineup following Fidelity Investments, which announced its plans earlier this month. In a press release issued yesterday, Federated announced phase one of its changes, which includes converting some of its Institutional Prime funds to 60-day maximum maturity funds, which are allowed to continue using amortized cost pricing, decreasing the likelihood that any "floating NAV" fund would actually float. (Recent news of big shifts into government funds may also guarantee enough spread to make these products viable.) Among other changes, it also plans to merge some of its money funds. Federated CEO Christopher Donahue has talked about plans to restructure the firm's money funds for several months since the Securities and Exchange Commission approved MMF reforms last July. Today's "News" outlines the changes.
The release explains, "Federated Investors, Inc., none of the nation's largest investment managers, today announced its preliminary plan to restructure its line of money market funds to meet the needs of its clients and to comply with regulations announced by the U.S. Securities and Exchange Commission (SEC) in July 2014. The regulations will be implemented in phases over the next 20 months and the resulting changes in Federated's money market fund lineup will take place over the same time frame. Federated will work closely with its clients to ensure their liquidity needs are met today and in the future, as the changes outlined below take effect no later than October 2016."
It says, "Federated has spent considerable time discussing product changes with clients and has begun taking steps to adjust its product line to address the needs of a broad array of customers. Federated anticipates that these and other changes will offer investors a full menu of product choices for liquidity management, including money market mutual funds and other options."
The release continues, "Federated will continue to offer Treasury and government money market funds. The company will also designate existing prime and municipal money market funds as either institutional or retail funds. In the retail money market fund category, the company plans to offer the following product types: prime money market funds, national municipal money market funds, state-specific municipal money market funds, variable annuity money market fund."
Further, "In the institutional money market fund category, the company plans to offer the following product types: prime money market funds, national municipal money market funds. Specifically with institutional prime money market funds, Federated anticipates converting certain existing funds to 60-day maximum maturity funds while other existing funds will remain 397-day maximum maturity funds. Decisions on categories for many products will be announced over the next several months with the end result being a continuation of money market fund choices that enables clients to do business with Federated in the manner in which they have grown accustomed."
Chris Donahue comments, "Federated has been a leading provider of liquidity management services for four decades, and we will continue to offer products suitable for all of our clients. Our clients have requested that we begin to share information on our product strategy for October 2016 and beyond, and this announcement will help clients move ahead with their liquidity planning solutions while laying the foundation for Federated to continue providing superior investment management and client service."
The release adds, "Many of the proposed changes will require approval from the funds' board of trustees and, in certain cases, shareholders. Accordingly, Federated will not begin to implement changes to the investment strategies or shareholder qualifications for its money market funds or solicit proxies from fund shareholders until these changes have received the necessary approvals and appropriate disclosures have been included in the funds' registration statements. In addition, further product changes may be required if the SEC issues additional guidance that impacts the funds."
Federated also announced it will not institute liquidity fees or redemption gates on its government and Treasury money market funds. "Government and Treasury money market funds were exempted from new liquidity fees and redemption gates provisions and will continue to seek a $1.00 net asset value (NAV). However, under the forthcoming rules, government and Treasury funds could voluntarily adopt gates and/or fees, as long as a fund's ability to do so is disclosed to investors. Per the new SEC rules, government money market funds will be defined as funds that invest at least 99.5% of total assets in government securities, cash and/or repurchase agreements that are fully collateralized (i.e., collateralized by government securities or cash). These requirements closely follow the manner in which Federated has historically managed and will continue to manage its government and Treasury money market funds," the release states.
The company said the following funds will not have liquidity fees and/or redemption gates -- Federated Automated Government Cash Reserves; Federated Liberty U.S. Government Money Market Fund; Federated Government Cash Series Federated Treasury Cash Series; Federated Government Reserves Fund Federated Treasury Obligations Fund; Federated Government Obligations Fund Federated Trust for Treasury Obligations; and Federated Government Obligations Tax Managed Fund Federated U.S. Treasury Cash Reserves.
The release continues, "Importantly, prime and municipal money market funds must be able to support liquidity fees and redemption gates by Oct. 14, 2016. Federated anticipates complying with these new rules on or about that date. Over the next several months, Federated plans to announce which prime and municipal money market funds will be structured as institutional money market funds and which will be structured as retail money market funds to meet the new rules. Although the SEC compliance date for the separation of institutional and retail investors is not until Oct. 14, 2016, Federated expects to announce its plans for institutional/retail designation prior to that date to give clients the opportunity to plan for their liquidity management needs.... Federated's retail money market funds will continue to seek $1.00 NAVs as they have for the past four decades."
Deborah A. Cunningham, CIO for Global Money Markets, tells us, "Federated has a strong reputation for the depth and experience of our cash management investment personnel. We are keenly focused on the many details required to meet the SEC guidelines while continuing to manage our portfolios with the highest standards possible and interacting with our clients to help them meet their liquidity management needs."
On the new 60-day maximum maturity funds, Federated says, "Subject to any required approvals, certain institutional prime and municipal money market funds will limit their investments to securities maturing in 60 days or less. Other institutional prime and municipal money market funds will continue to invest in securities with maturities of up to 397 days, the maturity limit under Rule 2a-7. Currently it is anticipated that institutional prime and municipal funds selected to be 60-day maximum funds will begin to gradually limit their investments in late 2015 to securities maturing on or before Dec. 14, 2016, which is 60 days post implementation, so that the funds can be restructured appropriately by Oct. 14, 2016."
The release explains, "As permitted under current rules and guidance, each time a 60-day maximum fund calculates its NAV per share, it will use amortized cost to value its portfolio securities as long as no market quotations are available and each such security's amortized cost approximates the security's fair value. Beginning on or about Oct. 14, 2016, the 60-day maximum funds will attempt to maintain an NAV of $1.0000 per share, and, under ordinary circumstances, the funds' per share price would be expected to experience little or no fluctuations. However, the funds' NAV may fluctuate if the amortized cost value of its securities no longer approximates the market value or if a fund is required to dispose of securities for something other than amortized cost. Federated believes that the short maturity of the securities held by the funds should help to limit the instances when these events may cause a fund's $1.0000 NAV per share to change."
Further, "Subject to notification and disclosure, Federated anticipates that on or about the compliance date for floating net asset value (Oct. 14, 2016), Federated will convert at least one of its products to a floating net asset value money market fund for clients seeking an institutional prime money market fund with potentially higher yields than the 60-day maximum money market funds. More details will be announced during the second quarter of 2015."
Finally, some MMFs will be merged. They write, "Subject to board approval, and in some cases shareholder approval, Federated plans to merge several of its money market funds into other money market funds with similar investment objectives and add new share classes to the surviving funds. These moves will enable the firm to continue offering clients a straightforward, robust and well-diversified choice of products and the ability for investors to do business with Federated in the manner and form in which they are accustomed. Funds that are expected to be merged will be announced in the next several months. Although Federated's plan announced today may be adjusted before the compliance dates for the money market fund reform rule, Federated believes the information presented will help clients move ahead with their liquidity planning solutions."
Will BlackRock be the next mega money manager to realign its money market fund lineup in response to the Securities and Exchange Commission's money market reforms? An article in Wednesday's Wall Street Journal says that indeed may be the case. The Journal piece, "Advisers Prepare for Changes to Money-Market Funds (finally) recaps the news that we've covered for a couple of weeks now, that Fidelity is converting three of its Prime Retail funds, including the $112 billion Fidelity Cash Reserves Fund, to a government fund due to investor demand. (See our Feb. 2 News, "Fidelity Announces Major Changes to MMFs; Staying Stable, Going Govt.") But it also examines what others have been wondering for the last two weeks: Will other managers do something similar? Federated has stated for months, before the Fidelity news came out, that it is considering money market fund changes in response to the SEC reforms. However, the Journal also reports that BlackRock, also a top 5 money manager in terms of assets, might be shaking things up, too.
The Journal writes, "Fidelity Investments' plans to revamp some of its money-market funds could be a sign of things to come as asset managers prepare for new regulations that are likely to transform the $2.7 trillion industry. The Boston money manager will convert three of its prime funds--which now invest in corporate debt--to government funds that invest in cash, government securities or repurchase agreements collateralized by government securities. Those changes may result in lower yields for investors now in the prime funds, and other money managers will likely follow suit.... Retail and government money-market funds may maintain their stable $1 share price under the regulations. But under the new rules, the boards of non-government money-market funds are permitted [required] to impose liquidity fees on shareholders for withdrawing assets and to suspend redemptions temporarily to thwart a run on a fund."
The story continues, "Those new conditions, however, are not popular with many investors. "Many investors have told us that they want access to money-market mutual funds with a stable net asset value that will not be subject to liquidity fees or redemption gates, which would restrict their use of the funds," Fidelity said. Matthew Tuttle, chief executive at Tuttle Tactical Management, is among those who doesn't want clients' access restricted. He makes extensive use of Fidelity's prime money-market funds, and says, "I'd rather have a government money-market fund than something that floats.""
The Journal writes, "Roger Merritt, managing director at Fitch Ratings, says any shift from a prime fund to a government fund will typically result in reduced yield for investors.... Exclude the crisis period from June 2007 to June 2008, and the average spread differential falls to six basis points in favor of prime funds, says Nancy Prior, president of fixed income at Fidelity. In essence, investors now have to make a choice on what's more important to them--a fund with a stable net asset value without the possibility of gates and fees or that "very small yield differential," Ms. Prior says."
The WSJ article continues, "Fidelity's plans, some of which require shareholder approval, are a wake-up call to money-market fund participants who had entered a period of calm given that almost no changes had been made by managers or investors since the new regulations were approved, says Vikram Rai, fixed-income strategist at Citigroup Inc. Other large players in the money-fund industry are already mulling changes."
It says, "BlackRock Inc. will likely convert its retail prime funds later this year, says Thomas Callahan, co-head of the firm's cash-management group. It has no plans currently to convert its institutional funds. And Federated Investors Inc. continues to work on product modifications and additions related to the new regulations, a spokesman says. To meet money-fund needs, its products will likely include prime and muni money-market funds modified to meet the new requirements, among other options, he says. The Vanguard Group is evaluating the reforms and the effect on its shareholders, a spokesman says. The vast majority of the asset-manager's money-fund investors are retail, he says, adding that the firm doesn't have any plans to convert its prime money-market funds into government money-market funds."
The article quotes Crane Data President Peter Crane as saying, "Explaining and preparing for the emergency gates and fees is scaring off boards of directors and sweep-fund directors [investors]," he says. "They don't want that small chance that their cash might be frozen at some point." Mr. Rai of Citigroup says the industry "will undergo a slightly unsettled phase as key players tweak their models." He anticipates some near-term outflows from institutional prime funds overall, but doesn't anticipate that the changes will open the floodgates for large outflows from institutional prime funds."
In other news, Fidelity Investments wrote surprisingly little on money market funds in its 2014 Shareholder Update. They say, "Money market funds continue to operate in a near-zero interest rate environment, and we saw $13 billion in managed money market fund outflows [in 2014]. Money market funds remain very important to our customers, and will continue to be an integral part of our business. Thanks to the hard work of associates across Fidelity, we are well prepared to make changes to our product offering and fund operations to comply with the SEC's new rules." In terms of performance, Fidelity's money market funds beat 69%, 72%, and 73% of peers for the trailing one-, three-, and five-year periods ended December 31, 2014, respectively, according to the annual report.
The preliminary agenda is available and registrations are now being taken for Crane Data's 7th annual Money Fund Symposium, which will take place June 24-26, 2015 at The Hilton Minneapolis, in Minneapolis, Minn.. Money Fund Symposium is the largest gathering of money market fund managers and cash investors in the world. Last summer's event in Boston attracted nearly 500 attendees, and we expect yet another robust turnout for our Minneapolis event this June. (Symposium participants include money fund managers, marketers and servicers, cash investors, money market securities dealers, issuers, and regulators.) Visit the MF Symposium website (www.moneyfundsymposium.com) for more details. Registration is $750, and discounted hotel reservations are also now available. We review the agenda and conference details below. (E-mail us at firstname.lastname@example.org to request the full brochure.)
The June 24 opening afternoon agenda includes: "Welcome to Money Fund Symposium 2015" by Peter Crane, President & Publisher of Crane Data; our keynote discussion, "The New Look of Money Market Funds" with Wells Fargo Advantage Funds' President Karla Rabusch; "State of the Money Fund Industry" with Peter Crane, Debbie Cunningham of Federated Investors, and Alex Roever of JP Morgan Securities; a "European & Global Money Fund Outlook," with Jonathan Curry of the Institutional Money Market Fund Association and Jim Fuell of JP Morgan Asset Management; and, finally, a panel moderated by Charles Schwab's Rick Holland entitled, "Major Money Fund Issues 2015," featuring Tom Callahan of BlackRock, John Donohue of J.P. Morgan A.M., and Nancy Prior of Fidelity. (The opening evening's reception will be sponsored by Bank of America Merrill Lynch.)
Day 2 of Money Fund Symposium 2015 features: "Repo Review & Money Market Observations" with Joseph Abate of Barclays and Lou Crandall of Wrightson ICAP; "Senior Portfolio Manager Perspectives," moderated by Garret Sloan of Wells Fargo Securities and including Danny Burke of Goldman Sachs AM, James Palmer of First American Funds, and Rob Sabatino of UBS Global Asset Management; "Government and Treasury Fund Issues," moderated by Andrew Hollenhorst of Citi, and featuring Mike Bird of Wells Fargo Advantage Funds, Jonathan Hartley of FHL Banks Office of Finance, and Sue Hill of Federated Investors; and "Muni & Tax Exempt Money Fund issues" with Colleen Meehan of Dreyfus.
The afternoon of Day 2 (after a Dreyfus-sponsored lunch) features: "Dealer Panel: Supply Update and Outlook," moderated by Peter Yi of Northern Trust and featuring Rob Crowe of Citi; Stewart Cutler of Barclays, and Ron Flynn of JP Morgan Securities; "MMF Alternatives: Ultra-Short, Private, SMAs," moderated by JPM's Alex Roever and featuring Jonathan Carlson of BofA Global Capital Management, David Martucci of JP Morgan Asset Management, and Paul Reisz of PIMCO; "Operational & Settlement Issues with Reform," with Tony Carfang of Treasury Strategies and Charles Hawkins of BNY Mellon Asset Servicing; and a "Money Fund Ratings Roundtable" with Robert Callagy of Moody's Investors Service, Roger Merritt of Fitch Ratings, and Peter Rizzo of Standard & Poor's Ratings. (The Day 2 reception is sponsored by Barclays.)
The third day of Symposium features: "Strategists Speak '15: Rates and Higher Rates," with Brian Smedley of Bank of America Merrill Lynch, Michael Cloherty of RBC Capital Markets, and Ira Jersey of Credit Suisse; "Money Fund Reforms: Questions on the Rule" with Stephen Keen of Reed Smith, Sarah ten Siethoff of the U.S. Securities & Exchange Commission, and Jack Murphy of Dechert LLP; "More on Money Fund Reforms: Adoption Issues" with Joan Swirsky of Stradley Ronon <i:http://www.stradley.com>`_ and Tim Schiltz of Ameriprise Financial. Finally, the last session is entitled, "Money Fund Data, Statistics, and Software," with Peter Crane presenting on the latest money fund information tools.
We hope you'll join us in Minneapolis this June! (We'd also like to encourage attendees, speakers and sponsors to register and make hotel reservations early.) In other conference news, Crane's 3rd annual "offshore" money fund event, European Money Fund Symposium, will be held in Dublin, Ireland, September 17-18, 2015. This website (www.euromfs.com) is also now live and accepting reservations, though we continue to tweak our preliminary agenda. (Contact us if you'd like to sponsor.) Finally, our next Money Fund University "basic training" event is tentatively scheduled for Jan. 21-22, 2016 in Boston. Watch www.cranedata.com in coming months for more details.
In other news, the NY Fed released yet another "Statement Regarding Term Reverse Repurchase Agreements." The latest one says, "As noted in the January 28, 2015, Statement Regarding Term Reverse Repurchase Agreements, the Federal Open Market Committee (FOMC) instructed the Open Market Trading Desk (the Desk) at the Federal Reserve Bank of New York to conduct a series of term RRP operations from mid-February through early March. These tests are intended to help the Desk examine how term RRP operations might work as an additional supplementary tool to help control the federal funds rate. The tests will consist of four one-week term RRP operations to take place on successive Thursdays. The amount offered and maximum offering rate associated with each operation will be announced on or around the Monday prior to the operation. A tentative schedule, updated to include additional details on the operation to be conducted on February 19, follows."
In his latest "Money Market Monitor" report, Garret Sloan, money market strategist at Wells Fargo Securities, analyzes the latest plot twist in the ongoing money market reform saga, i.e., Fidelity's announcement that it will be converting some $130 billion in prime funds to government funds, including the $112 billion Fidelity Cash Reserves. He believes there are three major factors that led to Fidelity's shift from prime retail. Sloan writes, "Those of you that are familiar with the George R.R. Martin series of books made popular to non-geeks by the HBO series Game of Thrones know of the progressively dark twists and turns that the author forces his characters to endure as the plots progress. The money market fund universe seems to have undergone its own "Red Wedding" moment last July, but until recently it appeared that while the industry was begrudging the change, it was nevertheless taking it in stride. That view may have completely changed this month as the market is digesting the recent news from Fidelity Investments that it has chosen to convert its largest prime money market fund, Fidelity Cash Reserves, along with two other smaller funds, to the government retail category."
Explains Sloan, "The change was like a shot heard round the world for the money fund industry, not only because the size of the fund makes ignoring it impossible, but also because Cash Reserves is a retail fund that has never needed to directly address the risk of a floating NAV. The proposed change indicates that the industry is perhaps a bit more worried about flows and structural reforms than the initial period of calm has suggested. The questions we face now are what are the changes that the money fund industry is facing that may have precipitated such a preemptive shift in strategy, and does this switch represent a turn of the tide for the entire prime money market fund space? We would suggest that there are factors, other than the floating NAV, that Fidelity believes place sufficient pressure on prime funds that would warrant the change. These include: 1. A permanent structural reduction in short-term investments options. 2. The reality that redemption gates and liquidity fees may turn out to be a bigger regulatory hurdle. 3. The additional structural issues involved with sweep-related money market fund products."
Concerning the first factor, supply, he writes, "It is no secret that money funds are heavily exposed to the bank sector. Both domestic and foreign holdings in prime funds are dominated by bank-related exposure. Regulatory changes in the banking sector are expected to place direct pressure on the supply of short-term bank-related assets, and it is likely that these assets will continue to diminish as these changes permeate the global banking landscape."
Sloan noted three such pressures: 1. Liquidity Coverage Ratio, which requires banks to maintain at least one dollar in high quality liquid assets (HQLA) for every dollar in short-term financial-related deposits,; (2) Net Stable Funding Ratio, which requires banks to maintain certain stable types of funding for less liquid assets; and (3) Supplementary Leverage Ratio, which puts "somewhat of a cap on certain repo funding as the SLR does not allow for the offsetting of exposure under "open repo" transactions, or those that do not have an explicit maturity date."
Regarding the second factor, fees and gates, Sloan contends, "Shifting gears away from the supply situation, we return to the question of Fidelity Investments and its proposed decision to transition Fidelity Cash Reserves from a prime retail fund into a government retail fund. Why is this being proposed in a retail fund? Will other fund families follow suit? Is this a bellwether event that will force other funds to follow suit? The first question is why retail and why not institutional? This can only be answered by the fact that gates and fees do not mix well with the Fidelity Cash Reserves’ client base."
He asks, "So who are the Fidelity Cash Reserves’ clients? It is our understanding that the fund is, among other things, a large investment vehicle for ... "sweep" products, and in Fidelity's estimation "sweep" products and redemption gates/liquidity fees are incompatible. That view is not necessarily shared by all market participants, and because other views exist, the fact that Fidelity chose this path does not mean that other fund providers will immediately follow."
Sloan continues, "An issue with the sweep vehicle is that sweep redemptions are often done on a "next day" basis with the money market fund as one "batch" transaction, but the cash being available to individual clients the same day. This is equivalent to the sweep provider lending money to the depositor on an overnight basis until the "batch" transaction with the money market fund can be conducted the next day. This makes sweep vehicles in the new 2(a)7 world difficult for two reasons."
"First," he writes, "if a sweep provider (bank) redeems a sweep depositor at one price but liquidates the position the next day at another price, the bank provider could potentially suffer a loss on the position and not be able to recoup the cost. It is likely that the sweep provider could quickly debit the account of the investor for the difference, but the risk exists that the investor could redeem all bank and fund balances, leaving the bank exposed to the price volatility of the fund portfolio. Second, Gates and Fees could be equally as difficult. Clearly they are, given that Fidelity chose to convert its retail prime funds. The issue again seems to do with the extension of overnight credit. In the event that a sweep provider delivers cash to a depositor and the next day, a gate is introduced on the fund, the bank sweep provider would be left with credit and liquidity exposure to the money market fund for up to ten days. Bank sweep providers are unlikely to be willing to accept this risk."
On sweeps he continues, "Fees are an equally sticky problem, in that a bank sweep provider could be exposed to the risk of paying a fee on a sweep redemption it has already made. However, alternative solutions are being discussed by other money market fund complexes, and we anticipate that fund providers will work with their bank sweep partners to solve the issue.... One relevant question is whether the lowering of a redemption gate introduces incremental credit risk to the sweep provider? Or did the risk exist all along? In our opinion, the answer is no ... and yes. Since the client has already been paid, the sweep provider is exposed to the failure of the fund whether a gate is in place or not. However, the provider is exposed to greater liquidity risk, and under the bank regulatory framework discussed in previous sections, it may be costly to provide short-term liquidity to regulated funds."
Sloan concludes, "Whether we have effectively made the argument that the transition of Fidelity Cash Reserves and its smaller prime siblings to a government retail fund is not the next shoe to drop for prime funds is yours to decide. What we do know is that we fully expect other money market fund complexes to continue exploring other options. We suspect that time will be needed for investors to warm up to any of the options trickling into the market, and flows will move to the options most palatable to that client base."
He adds, "Conversely, while we wait for other fund complexes to address 2(a)7 regulatory issues in their own ways, we would suggest that if other money market funds follow Fidelity's lead, the pressure that banks may feel as a result of a reduced buyer base could cause the shape of the short-term bank funding curve to twist even more awkwardly, presenting even stronger relative value opportunities for short-term investors that can buy beyond the money markets."
Finally, Sloan comments, "For our part, we do not anticipate a stampede of funds following Fidelity's lead, even in the sweep product market. Nor do we believe that Fidelity's pivot suggests a shifting belief that 2(a)7 funds no longer have a strong value proposition. The landscape for money market funds is riddled with supply and demand challenges, but we believe more opportunities than risks exist for investors that can flexibly deploy cash."
There's been a lot of discussion about the future of prime funds since the SEC approved money market reforms last July, and rightfully so. But prime funds shouldn't be the only concern of MMF investors. Government funds, which came away from reforms largely unscathed, face their own set of challenges in a post-reform world, especially with a potential flood of new assets. Columbia Management's John McColley, portfolio manager, Liquidity Strategies, and Alice Flynn, senior product manager, discuss these issues in a new commentary, "Challenges Facing Government Money Market Funds." One of the biggest challenges will be lower yields, they say, so, "Investors seeking a higher yielding product may look to combining a government money market fund with one or more floating NAV retail funds." (Note: We also interview Columbia Management Ultra Short Manager Leonard Aplet, who has some comments on money fund reforms and alternatives, in the pending February issue of our new Bond Fund Intelligence.)
They write, "Six months have already passed since the SEC approved sweeping money market reforms to Rule 2a-7. However, most firms have yet to make a final decision on what money market products to include in their investment lineup come October 2016. Unlike the changes instituted in 2010 where fund managers had time to allow portfolios to shorten weighted average maturities naturally, these new changes will be much more disruptive to both investors and issuers in the short term markets. The cost to implement these new regulations (800+ pages of reforms) may prove to be prohibitive for smaller funds, with some firms already waiving the white flag."
Columbia continues, "For those still working through the systems/process changes and website modifications, a conundrum exists. Firms want to convert to the products that will be most desirable to their shareholders, but shareholders don't know what they want yet and are waiting to see what will be available. With time on the side of the investor, those firms that want to continue to be in the money market business are considering all options to retain and gather assets."
One option is government money market funds. "On the surface, this option appears to be the easiest solution for mutual fund families to implement and the structure of the fund will remain the closest to what investors are familiar with. However, government money market funds have been newly defined as investing 99.5% of their assets in cash, government securities or repurchase agreements that are fully collateralized. Shareholders will continue to use a stable $1 NAV and won't need to worry about redemption fees or liquidity gates. Fund families that change their institutional funds to government funds will also be able to retain the existing shareholder base as both natural persons and institutional investors can remain in the fund together.... Unfortunately, it is not possible or logical for all institutional or retail money market funds to convert to government money market funds, given so many variables and challenges that exist."
Will there be enough supply? They write, "[T}he September 30 available supply of short government paper totaled about $3.8 trillion, with roughly $1.5 trillion in T-Bills, $1.25 trillion in Treasury notes and bonds within one year of maturity, and an additional $1.1 trillion in qualifying agency securities. Should budget deficits decline, Treasury issuance will most certainly decline as well. Additionally, ICI reported that "as of June 2014, taxable money market funds held just $377 billion – or 13 percent – of short-term debt issued by the Treasury." The remaining supply of these securities is already owned by central banks, state and municipal governments, commercial banks and existing separate cash accounts. Even as the Fed begins to raise rates, the added demand from government money market funds to a potentially shrinking investable universe will cause spreads to widen and government securities to yield less than other money market securities."
They continue, "Within the Government Agency category, Federal Home Loan Bank (FHLB) has been a big issuer of debt but there is uncertainty whether Fannie Mae (FNMA) and Freddie Mac (FHLMC), both big agency issuers of agency discount notes, will continue to exist. There is also a question as to the long term access to the Fed's ON RRP (Overnight Reverse Repo Program). Usage typically spikes during quarter ends and the new money market reforms are expected to add to the short term market's reliance on this program as the scarcity of investable short-term Treasuries generally drives the importance of the RRP. If the Fed were to end the program, a reliable supply of government securities would be significantly impacted. Market participants have also speculated that an aggregate cap could be imposed on the facility, thereby restricting the supply of government securities when there could be increased demand."
A big challenge for government MMFs will be yield. They explain, "A government money market fund's inability to invest in spread products -- CP, ABCP, CD, VRDNs and legacy repo -- will limit the yield and total return potential. Government securities are already limited in their return potential given the additional yield that these other security types generally offer (in exchange for higher risk). Also, increased demand for Treasury and Agency securities will drive their prices higher and reduce the yield potential of the government securities even more."
Also, the competitive landscape will likely be more crowded. Columbia writes, "According to Peter Crane, president of Crane Data, a research firm that tracks money market funds, "the general consensus is that the big players in the money market industry are going to be prepared to offer all three types of money market funds, as well as develop other products where they see potential asset growth." Additional products under consideration for those investors looking for more yield and to avoid fees and gates include short-term bond and ultra short-term bond funds, private funds, expanding separate accounts business, and Federated is considering a 60-days and under maturity product, which keeps it under the SEC's money market reform radar."
What does the future hold? They conclude, "There will always be a long-term need for short-term assets, whatever one's investment style. Investors with no risk tolerance or who are required by regulatory guidelines or investment constraints mandating a stable $1 NAV will likely be the ones who gravitate towards government money market funds. Such funds may provide peace of mind and liquidity, but will be challenged to offer a competitive yield. On the other hand, investors seeking a higher yielding product may look to diversify their investments between multiple funds. Combining a stable $1 NAV government money market fund with one or more floating NAV retail funds may help investors increase the likelihood that the cash they may need will be available when they want it, should one or more funds be impacted by fees and gates. Whatever the flows may be in the category, it will be up to individual investors to determine their needs for cash investments and to select the investment products that best fit those needs."
Crane Data released its February Money Fund Portfolio Holdings yesterday, and our latest collection of taxable money market securities, with data as of Jan. 31, 2015, shows a jump in Other (Time Deposits), VRDNs, CP, CDs, and Agencies, and drops in Repo and Treasuries. Money market securities held by Taxable U.S. money funds overall (those tracked by Crane Data) increased by $5.6 billion in January to $2.525 trillion after rising $68.3 billion in December, $11.5 billion in November, $4.7 billion in October, and $42.4 billion in September. With a decrease in Fed RRP holdings, Repo fell out of the top spot, replaced by CDs, which became the largest portfolio segment among taxable money market funds. Treasuries ranked as the third largest segment, followed by CP, which moved back ahead of Agencies. These were followed by Other (Time Deposits), then VRDNs. Money funds' European-affiliated holdings jumped up to 29.3% from 20.0% the previous month, while the Americas market share fell to 58.8% from 67.9% (as the quarter-end spike in Fed repo receded. Below, we review our latest Money Fund Portfolio Holdings statistics.
Among all taxable money funds, Certificates of Deposit (CDs) were up $28.0 billion (5.3%) in January to $556.4 billion, or 22.0% of assets, after dropping $34.8 billion in December, increasing $11.3 billion in November, increasing $5.6 billion in October, and dropping $20.1 billion in September. Repurchase agreement (repo) holdings fell to second place, dropping $141.5 billion in January (-21.4%) to $520.9 billion, or 20.6% of assets, after increasing $140.3 billion in December and $10.8 billion in November, decreasing $85.3 billion in October, and increasing $84.4 billion in September.
Treasury holdings, the third largest segment, fell $38.3 billion (-8.7%) to $403.6 billion, or 16% of holdings, after increasing by $56.0 billion in December. Commercial Paper (CP) moved up to the fourth largest segment, jumping $35.3 billion (10.0%) to $389.2 billion, or 15.4% of assets, while Government Agency Debt fell to fifth, increasing $18.0 billion (4.9%) to $385.2 billion, or 15.3% of assets. Other holdings, which include primarily Time Deposits, jumped sharply, up $98.3 billion (69.8%) to $239.1 billion, or 9.5% of assets. VRDNs held by taxable funds increased by $5.8 billion to $30.3 billion (1.2% of assets).
Among Prime money funds, CDs still represent over one-third of holdings with 35.3% (up from 34.7% a month ago), followed by Commercial Paper (24.7%). The CP totals are primarily Financial Company CP (14.7% of holdings) with Asset-Backed CP making up 5.8% and Other CP (non-financial) making up 4.2%. Prime funds also hold 6.3% in Agencies (up from 5.6%), 4.4% in Treasury Debt (down from 4.8%), 3.5% in Other Instruments, and 6.0% in Other Notes. Prime money fund holdings tracked by Crane Data total $1.577 trillion (up from $1.523 trillion last month), or 62.4% of taxable money fund holdings' total of $2.525 trillion.
Government fund portfolio assets totaled $472 billion in January, down from $482 billion in December, while Treasury money fund assets totaled $476 billion in January, down from $514 billion at the end of December. Government money fund portfolios were made up of 60.1% Agency Debt, 21.5% Government Agency Repo, 2.7% Treasury debt, and 15.1% in Treasury Repo. Treasury money funds were comprised of 67.6% Treasury debt, 31.3% Treasury Repo, and 1.0% in Government agency, repo and investment company shares.
European-affiliated holdings skyrocketed $234.5 billion in January to $738.9 billion (among all taxable funds and including repos); their share of holdings rose to 29.3% from 20.0% the previous month. Eurozone-affiliated holdings also jumped, up $133.3 billion to $410.1 billion in January; they now account for 16.2% of overall taxable money fund holdings. Asia & Pacific related holdings decreased by $2.8 billion to $300.0 billion (11.9% of the total). Americas related holdings plunged $228.0 billion to $1.483 trillion, and now represent 58.8% of holdings. (Over $193 billion of the U.S. decline was due to a drop in Fed repo.)
The overall taxable fund Repo totals were made up of: Treasury Repurchase Agreements (down $173.6 billion to $267.6 billion, or 10.6% of assets), Government Agency Repurchase Agreements (up $31.6 billion to $162.8 billion, or 6.4% of total holdings), and Other Repurchase Agreements (up $500 million to $90.5 billion, or 3.6% of holdings). The Commercial Paper totals were comprised of Financial Company Commercial Paper (down $26.3 billion to $231.4 billion, or 9.2% of assets), Asset Backed Commercial Paper (up $600 million to $91.1 billion, or 3.6%), and Other Commercial Paper (up $8.3 billion to $66.6 billion, or 2.6%).
The 20 largest Issuers to taxable money market funds as of Jan. 31, 2015, include: the US Treasury ($403.6 billion, or 16.0%), Federal Home Loan Bank ($228.1B, 9.0%), Federal Reserve Bank of New York ($159.1B, 6.3%), Credit Agricole ($70.9B, 2.8%), BNP Paribas ($69.2B, 2.7%), Federal Home Loan Mortgage Co ($62.4B, 2.5%), JP Morgan ($60.6B, 2.4%), Wells Fargo ($59.5B, 2.4%), RBC ($54.9B, 2.2%), Bank of Tokyo-Mitsubishi UFJ Ltd ($54.7B, 2.2%), Bank of Nova Scotia ($52.8B, 2.1%), Natixis ($50.0B, 2.0%), Federal National Mortgage Association ($48.9B, 1.9%), Bank of America ($45.1B, 1.8%), Toronto-Dominion Bank ($43.1B, 1.7%), Sumitomo Mitsui Banking Co ($43.1B, 1.7%), Federal Farm Credit Bank ($42.3B, 1.7%), Barclays PLC ($41.2B, 1.6%), Citi ($41.2B, 1.6%), and DnB NOR Bank ASA ($40.3B, 1.6%).
In the repo space, Federal Reserve Bank of New York's RPP program issuance (held by MMFs) remained the largest program with $159.1B, or 30.6% of the repo market, down sharply from 53.2% one month ago. Of the $159.1B, all of it was in Overnight Repo. The 10 largest Repo issuers (dealers) (with the amount of repo outstanding and market share among the money funds we track) include: Federal Reserve Bank of New York ($159.1B, 30.6%), BNP Paribas ($44.0B, 8.4%), Bank of America ($36.3B, 7.0%), Credit Agricole ($29.7B, 5.7%), Societe Generale ($27.6B, 5.3%), Wells Fargo ($24.6B, 4.7%), JP Morgan ($23.5B, 4.5%), Citi ($21.8B, 4.2%), Barclays PLC ($20.5B, 3.9%), and Credit Suisse ($20.4B, 3.9%).
The 10 largest issuers of CDs, CP and Other securities (including Time Deposits and Notes) combined include: Bank of Tokyo-Mitsubishi UFJ Ltd ($46.4B, 4.6%), Sumitomo Mitsui Banking Co ($43.1B, 4.1%), Natixis ($41.1B, 3.9%), Toronto-Dominion Bank ($38.7B, 3.7%), DnB NOR Bank ASA ($38.3B, 3.6%), RBC ($37.7B, 3.6%), Bank of Nova Scotia ($37.6B, 3.6%), Credit Agricole ($37.1B, 3.5%), JP Morgan ($36.7B, 3.5%), and Wells Fargo ($34.8B, 3.3%).
The 10 largest CD issuers include: Toronto-Dominion Bank ($38.0B, 6.9%), Bank of Tokyo-Mitsubishi UFJ Ltd ($37.1B, 6.7%), Sumitomo Mitsui Banking Co ($36.5B, 6.6%), Bank of Nova Scotia ($30.6B, 5.6%), Mizuho Corporate Bank Ltd ($29.1B, 5.3%), Bank of Montreal ($26.7B, 4.8%), Wells Fargo ($25.0B, 4.5%), Rabobank ($22.2B, 4.0%), Natixis ($21.0B, 3.8%), and RBC ($19.1B, 3.5%).
The 10 largest CP issuers (we include affiliated ABCP programs) include: JP Morgan ($25.7B, 7.7%), Commonwealth Bank of Australia ($17.9B, 5.4%), Westpac Banking Co ($16.7B, 5.0%), RBC ($14.9B, 4.5%), National Australia Bank Ltd ($11.8B, 3.5%), Australia & New Zealand Banking Group Ltd ($11.5B, 3.4%), BNP Paribas ($10.2B, 3.1%), Toyota ($9.5B, 2.9%), DnB NOR Bank ASA ($9.5B, 2.8%), and Lloyds TSB Bank PLC ($9.0B, 2.7%).
The largest increases among Issuers include: Credit Agricole (up $32.5B to $70.9B), DnB NOR Bank ASA (up $24.8B to $40.3B), Credit Mutuel (up $17.2B to $22.8B), Societe Generale (up $16.6B to $37.9B), Swedbank AB (up $16.1B to $28.7B), Natixis (up $15.8B to $50.0B), Barclays PLC (up $15.8B to $41.2B), BNP Paribas (up $13.8B to $69.2B), Skandinaviska Enskilden Banken AB (up $13.4B to $28.5B), and Federal Home Loan Bank (up $12.4B to $228.1B).
The largest decreases among Issuers of money market securities (including Repo) in January were shown by: Federal Reserve Bank of NY (down $193.4B to $159.1B), US Treasury (down $39.1B to $403.6B), Bank of Montreal (down $6.9B to $31.9B), Toronto-Dominion Bank (down $3.0B to $43.1B), Rabobank (down $2.3B to $26.9B), JP Morgan (down $2.3B to $60.6B), Bank of America (down $1.9B to $45.1B), Norinchukin Bank (down $1.7B to $10.3B), Goldman Sachs (down $1.2B to $10.4B), and Sumitomo Mitsui Banking Co. (down $1.1B to $43.1B).
The United States remained the largest segment of country-affiliations; it represents 50.0% of holdings, or $1.263 trillion (down $216B). France (10.4%, $263.1B) jumped up to second, moving ahead of Canada (8.7%, $218.3B), which fell to third. Japan (7.1%, $178.1B) fell to fourth, while the U.K. (4.7%, $118.7B) moved up to fifth. Sweden (4.6%, $116.1B) jumped to sixth, leapfrogging Australia (3.6%, $90.6B), which fell to seventh. The Netherlands (2.8%, $70.3B), Germany (2.1%, $54.1B), and Switzerland (2.1%, $53.2B) round out the top 10 among country affiliations. (Note: Crane Data attributes Treasury and Government repo to the dealer's parent country of origin, though money funds themselves "look-through" and consider these U.S. government securities. All money market securities must be U.S. dollar-denominated.)
As of Jan. 31, 2015, Taxable money funds held 26.4% of their assets in securities maturing Overnight, and another 13.6% maturing in 2-7 days (40.0% total matures in 1-7 days). Another 21.7% matures in 8-30 days, while 12.1% matures in 31-60 days. Note that almost three-quarters, or 73.8% of securities, mature in 60 days or less, the dividing line for use of amortized cost accounting under the new pending SEC regulations. The next bucket, 61-90 days, holds 10.6% of taxable securities, while 11.1% matures in 91-180 days and just 4.2% matures beyond 180 days.
Crane Data's Taxable MF Portfolio Holdings (and Money Fund Portfolio Laboratory) were updated Wednesday, and our MFI International "offshore" Portfolio Holdings and Tax Exempt MF Holdings will be released later this week. Visit our Content center to download files or visit our Portfolio Laboratory to access our "transparency" module. Contact us if you'd like to see a sample of our latest Portfolio Holdings Reports or our new Holdings Reports Issuer Module.
Now that the clock is ticking on the implementation of money market reforms, money managers are starting to think about post-reform strategies. Some, like Fidelity and Goldman Sachs Asset Management, have already announced some reform-related changes, while others, like Federated Investors, have talked publicly about potential changes to their money fund lineups. Recently, Stephen Bonte, Senior Portfolio Specialist at BNY Mellon's Standish, wrote a paper entitled, "The Implications of Regulatory Reform on Your Cash: Life After Money Market Reform, Basel III, and Dodd-Frank," on the subject. Also, Fitch Ratings published an update this week, "Fund Managers Begin Positioning for Money Market Reform," in which they review some post-reform maneuverings. Below, we look at both.
In the Standish paper, Bonte writes, "Multiple regulatory reforms mulled post-GFC (Global Financial Crisis) have now been finalized, and are close to reaching their implementation phase. Their stated objective is to make the financial system more resilient both systematically and idiosyncratically. This section highlights those changes most likely to impact the makeup of deposit and short-term fixed income markets."
He continues, "Money market fund reform, voted on July 23rd, 2014, confirmed the move to a floating Net Asset Value (NAV) and triggers for liquidity gates and/or liquidity fees for institutional investors in Prime and Tax-Exempt 2a-7 Money Market funds by the end of 2016. We estimate that approximately 40% of the assets in the $2.6 trillion Money Market funds universe will be impacted. How much of these $600 billion end up being reallocated, and where, remains to be seen. The consensus is that the natural destination for these monies is Treasury and Government Money Market funds."
Bonte explains, "This demand-driven rebalancing should result in a relative re-pricing of the front end, with an increased yield differential between short credit (Commercial Paper, Certificates of Deposit) and U.S. Treasury Bills/Agencies Discount Notes. Indeed, there is little reason to believe that the U.S. Treasury will increase Treasury Bills issuance to meet the increased demand. In fact, the U.S. Treasury has been de-emphasizing reliance on short-term funding.... [T]he amount of U.S. Treasury Bills outstanding has stabilized at around USD 1 trillion."
Further, he adds, "We anticipate that reform will meet its objective of reducing systemic risk by strengthening the principal preservation and liquidity feature of popular cash vehicles such as 2a-7 Money Market Funds and bank deposits, but that these safe and liquid vehicles will now come at a price -- e.g. at lower yields relative to other short-end instruments. And those yield differentials could be significant; for example, back-of-the envelope calculations suggest that to maintain current profitability metrics (ROE/ROA) the required spread between Interest On Excess Reserves (IOER) and unwanted deposits could increase to a 0.40% to 0.60% range, from the current 0.17% value."
Finally, Bonte writes, "While banks are unlikely to pass those costs on directly in a zero rate environment, even a partial cost-sharing with depositors could significantly alter pricing dynamics in the front-end of the yield curve. We expect that the tiering of relative yields to come in earnest if the Federal Reserve lifts target rates off from the zero level in place since 2008. Given these developments, we believe that the flexibility of separately managed accounts (SMAs) will make them an attractive complement to bank deposits and money market funds going forward. It serves as a transparent and fee-efficient vehicle to optimize yield given principal preservation and liquidity constraints. Perhaps more importantly, it inherently diversifies credit risk and taps alternative sources of liquidity."
Fitch's latest release also looks at how money fund managers are adapting to reforms. "Six months after the SEC voted on reforms, money fund managers are beginning to take steps to comply with the new rules and position themselves to retain and attract clients. While clients continue to be patient and industry assets remain stable, fund managers are launching, closing, and merging funds, updating investment guidelines, and working through the operational aspects of reform."
It continues, "Despite widespread predictions of outflows from institutional prime money funds -- those most impacted by the reforms -- so far asset flows have been positive. According to iMoneyNet data, total money fund assets increased by 6.2% since July 2014, when the reforms were passed, with institutional government funds growing faster than prime, 11.0% to 4.8%. Money fund flows typically incorporate seasonal factors, and it is too early to tell if the stronger flows into government funds (which are less impacted by reforms) are indicative of clients repositioning their cash holdings in response to reform. Investors are likely to shift some cash out of institutional prime funds closer to the effective date of the main thrust of the reforms, in October 2016."
Fitch explains, "Money fund managers are also taking steps to restructure their funds to gain a competitive position. Fidelity recently announced that it will convert a number of large retail prime money funds (with assets north of $100 billion) to government funds. Fidelity said many of its clients had indicated that they would prefer the stable NAV and exemption from the fees and gates provisions of the reform that government funds offer. This was also Goldman Sachs' rationale when it noted recently that its government funds are now in compliance with the reforms and that they have opted out of the fees and gates provision. Finally, a number of money fund managers have announced they will be merging or liquidating funds that have not attracted enough assets, with some small managers like Touchstone Investments exiting the business as the burdens and costs of compliance with the new reforms prove too high."
It goes on, "While government funds are expected to take up most of the money leaving prime money funds, some cash will likely find its way to other short-term products, including ultra-short bond funds, private 3c-7 money funds, and separately managed accounts. Fund managers have been discussing these options over the past few months with clients that may not want to remain in prime money funds with a floating NAV. A few managers have launched new ultra-short bond funds in recent months as an alternative to prime money funds. The bond funds, launched by large money fund managers like Goldman Sachs, Invesco, and Western Asset, typically strive to offer higher yields than prime money funds, and take slightly more risk. For example, the Goldman Sachs Limited Maturity Obligations Fund, rated 'AAA/V1' by Fitch, is allowed by prospectus to have a weighted average maturity (WAM) of as much as 270 days, compared to a maximum of 60 days for money funds."
Crane Data will publish its latest Money Fund Intelligence Family & Global Rankings Tuesday, which rank the asset totals and market share of managers of money market mutual funds in the U.S. and globally. The February edition, with data as of Jan. 31, 2015, shows asset decreases for a majority of money fund complexes in the latest month. However, most managers show strong gains over the past three months (due to a strong Q4 2014). Assets declined by $50.3 billion, or 1.9%, in January; over the last 3 months, assets are up $60.8 billion, or 2.4%. For the past 12 months through Jan. 31, total assets are down $19.6 billion, or 0.7%. Below, we review the latest market share changes and figures. These "Family" rankings are available to our Money Fund Wisdom subscribers.
Northern, HSBC, UBS and Invesco were among the few gainers in January, rising by $1.9 billion, $1.4 billion, $1.3 billion, and $935 million, respectively. (Northern moved ahead of SSgA into 11th place). BlackRock, JP Morgan, Goldman Sachs, Northern, and Dreyfus led the increases over the 3 months through Jan. 31, 2015, rising by $19.3B, $9.6B, $7.9B, $6.4B, and $5.8B billion, respectively. The only other complexes among the 25 largest seeing gains in January were: Rydex ($378M), SSgA ($374M) and Reich & Tang ($44M), according to our Money Fund Intelligence XLS.
Our latest domestic U.S. money fund Family Rankings show that Fidelity Investments remained the largest money fund manager with $404.9 billion, or 15.6% of all assets (down $8.9 billion in January, up $992M over 3 mos., and down $16.9B over 12 months), followed by JPMorgan's $256.0 billion, or 9.8% (down $3.4B, up $9.6B, and up $1.7B for the past 1-month, 3-months and 12-months, respectively). BlackRock remained in third with $216.4 billion, or 8.3% of assets (down $5.4B, up $19.3B, and up $14.4B). Federated Investors was fourth with $210.6 billion, or 8.1% of assets (down $5.3B, up $3.2B, and down $17.3B), and Vanguard ranks fifth with $172.1 billion, or 6.6% (down $1.6B, down $86M, and down $2.6B).
The sixth through tenth largest U.S. managers include: Dreyfus ($166.9B, or 6.4%), Schwab ($164.2B, 6.3%), Goldman Sachs ($151.0B, or 5.8%), Wells Fargo ($115.6B, or 4.4%), and Morgan Stanley ($109.4B, or 4.2%). The eleventh through twentieth largest U.S. money fund managers (in order) include: Northern ($82.4B, or 3.2%), SSgA ($82.3B, or 3.2%), Invesco ($60.9B, or 2.3%), BofA ($48.5B, or 1.9%), Western Asset ($45.1B, or 1.7%), First American ($42.1B, or 1.6%), UBS ($39.0B, or 1.5%), Deutsche ($32.7B, or 1.3%), Franklin ($18.7B, or 0.7%), and RBC ($16.7B, or 0.6%). Crane Data currently tracks 72 managers, the same number as last month.
Over the past year through January 31, 2015, BlackRock showed the largest asset increase (up $14.4B, or 7.1%), followed by Goldman Sachs (up $9.1B, or 6.4%), Morgan Stanley (up $8.6B, or 8.5%), Northern (up $6.7B, or 8.8%), and First American (up $4.2B, or 11.2%) <b:>`_. Other asset gainers for the year include: HSBC (up $3.7B, or 34.8%), Western (up $3.2B, or 7.7%), American Funds (up $2.2B, or 16.0%), JP Morgan (up $1.7B, or 0.7%), and SEI (up $1.4B, or 11.8%). The biggest decliners over 12 months include: Federated (down $17.3B, or -7.6%), Fidelity (down $16.9B, or -4.0%), UBS (down $6.1B, or -13.4%), Dreyfus (down $4.4B, or -2.6%), and RBS (down $4.2B, or -20.1%). (Note that money fund assets are very volatile month to month.)
When European and "offshore" money fund assets -- those domiciled in places like Dublin, Luxembourg, and the Cayman Islands -- are included, the top 10 managers match the U.S. list, except for Goldman moving up to No. 4, and Western Asset appearing on the list at No. 9. (displacing Wells Fargo from the Top 10). Looking at the largest Global Money Fund Manager Rankings, the combined market share assets of our MFI XLS (domestic U.S.) and our MFI International ("offshore"), the largest money market fund families are: Fidelity ($411.3 billion), JPMorgan ($384.3 billion), BlackRock ($339.5 billion), Goldman Sachs ($232.5 billion), and Federated ($219.3 billion). Dreyfus/BNY Mellon ($193.2B), Vanguard ($172.1B), Schwab ($164.2B), Western ($132.2B), and Morgan Stanley ($127.2B) round out the top 10. These totals include offshore US Dollar funds, as well as Euro and Pound Sterling (GBP) funds converted into US dollar totals.
Also, our February 2015 Money Fund Intelligence and MFI XLS show that yields remained largely unchanged in January. Our Crane Money Fund Average, which includes all taxable funds covered by Crane Data (currently 836), remained at 0.02% for both the 7-Day Yield and the 30-Day Yield (annualized, net) Average. The Gross 7-Day Yield moved up a tick to 0.14%. Our Crane 100 Money Fund Index shows an average 7-Day Yield and 30-Day Yield of 0.03%, same as last month. (The Gross 7- and 30-Day Yields for the Crane 100 remained at 0.17%.) For the 12 month return through 1/31/15, our Crane MF Average returned a record low of 0.01% and our Crane 100 returned 0.02%.
Our Prime Institutional MF Index yielded 0.03% (7-day), while the Crane Govt Inst Index moved back up to 0.02% (from 0.01%). The Crane Treasury Inst, Treasury Retail, Govt Retail and Prime Retail Indexes all yielded 0.01%. The Crane Tax Exempt MF Index also yielded 0.01%. (The Gross Yields for these indexes were: Prime Inst. 0.21% (up from 0.20%), Govt Inst. 0.10% (same as last month), Treasury 0.07% (up from 0.06%), and Tax Exempt 0.11% in January.) The Crane 100 MF Index returned on average 0.00% for 1-month, 0.01% for 3-month, 0.00% for YTD, 0.02% for 1-year, 0.04% for 3-years (annualized), 0.05% for 5-year, and 1.54% for 10-years.
The big news last week that Fidelity plans to convert three of its prime funds to government funds has left many wondering about the implications and possible ripple effects, including industry strategists Joseph Abate from Barclays and Vikram Rai from Citi Research, who shared their perspectives this week. Fidelity announced last Friday that it was reorganizing some of its money market funds in response to investor demand and recent money market reform. (See our News stories, "Fidelity Announces Major Changes to MMFs; Staying Stable, Going Govt" and "NY Fed Alters Fed Funds, Adds Funding Rate; More on Fidelity Changes.") Fidelity plans to convert three of its prime funds to government funds late this year, including the $112 billion Fidelity Cash Reserves, the world's largest money fund, and merge several other MMFs. (Note: Fidelity hasn't commented on plans for its Institutional money fund lineup yet, but we expect some kind of statement reaffirming the firm's commitment to "prime" later this week.)
In his commentary, "Change of Status," Barclay's Joe Abate said one of the impacts is that it will raise bank unsecured funding costs and push bill and government repo rates lower. He writes on the pre-Fidelity announcement environment, "Despite the prospect of unpopular reform, money fund investors in prime institutional funds have not begun leaving for stable value alternatives. Instead these balances are about 7% higher than their May 2014 level. Flows into institutional government-only funds have been stronger, but without a decline in prime fund balances it is difficult to see evidence that money fund investors are re-allocating to avoid upcoming regulations. In the absence of any investor flight, money fund managers have made few changes to their portfolio composition or the maturities of the securities held. Prime institutional money funds hold about 60% of their assets in bank-issued CP and CDs."
He adds, "However, it seems that if prime funds were worried about a potential mass departure of investors to stable NAV alternatives, they would have reduced their holdings of bank paper by letting them roll off and increasing their government repo and debt positions. Clearly this could still occur, but it seems that the initial industry reaction has been to take an overtly wait-and-see attitude."
Abate continues, "This seeming "business-as-usual" attitude got a rude shock late last week. Managers of the largest US prime money fund announced plans to convert into a government-only fund pending a shareholder vote in March. Two other much smaller funds will also convert to government-only funds. The three funds together have just under $130bn in assets under management. And, like the industry in aggregate, these funds' holdings are concentrated in bank unsecured paper such as CP and CD. They hold roughly $100bn of this paper -- or 75% of total assets. The remaining assets are split across repo and government debt -- largely held to meet the SEC's overnight and 7d liquidity buffer requirements. Their Treasury repo holdings (just $3bn at the end of November and a bit higher at the end of December) are exclusively with the Federal Reserve as counterparty."
Abate goes on, "The fund managers of these three funds face a difficult task over the next 6 [months]. They will need to divest their holdings of everything other than government debt and repo backed by government debt. Assuming these funds adopt the average asset allocation of the typical government-only money fund, they would need an additional $35bn and $43bn in Agency and Treasury debt, respectively. They would also need to source an additional $11bn and $27bn in Agency and Treasury repo, respectively."
He adds, "Finding an adequate supply of replacement government debt could be difficult. First, the Treasury is set to issue fewer bills this year. And while the supply of short-term (under 397d) Treasury coupon debt is roughly equal to the total amount of outstanding bills, nearly all this supply is locked up by final investors and is unlikely to come back into the market before maturity.... Second, as is apparent in the recurring quarter-end crash in money fund repo holdings, securing bank repo is getting more difficult as balance sheet pressures push banks to ratio the supply of collateral. We think that divesting their bank obligations will be much easier. Given the maturity of this paper and their desire to complete the conversion by the end of 2015, we expect these funds will start letting their CP, CD, and other unsecured bank obligations roll off at maturity."
Further, "The size of the asset re-allocation ($100bn) is probably large enough to have a significant effect on short rates. First, we expect that the extra $100bn in demand for bills, 2y tFRNs, Agencies, and government repo will push those yields sharply lower throughout the year -- even with the Fed expected to raise interest rates midyear. Estimating the magnitude of the downside pressure on these rates is difficult -- particularly given their already low levels. That said, we think it is safe to assume that the spread between (market) Treasury repo and the overnight RRP rate will narrow -- from 8bp currently -- to perhaps 4bp or less. The spread was below 4bp for most of last year. We expect 3m bills and shorter will trade 5bp or more below the overnight RRP rate. These effects are likely to become more pronounced in Q3 and Q4 as these money funds' bank holdings are replaced."
Also, he says, "All things equal, and given the similarity between investors and lenders in the fed funds and repo markets, we would expect that lower (market) Treasury repo rates would pull the effective funds rate down. We think the term unsecured rates will behave differently than the effective funds rate.... But, the scale of the effect on CP and other bank unsecured bank funding rates depends on the type of borrowing bank and whether other prime funds adopt the same "status change" strategy."
Barclays' Abate writes, "Industry-wide there is $1400bn in prime funds of which roughly $900bn is in institutional funds. On average roughly 60% of these balances are invested in bank CP and CDs. Thus the wholesale conversion of prime funds into government-only funds would shift between $540bn and $840bn worth of unsecured bank debt into government paper and repo. We suspect that this would be massively disruptive -- pushing government debt and repo rates sharply lower as Libor and rates on bank CP and CDs surge. Moreover, the rate implications of shift don't require all prime funds to disappear. Since the money fund industry is so highly concentrated even if only one or two money fund sponsors decides to follow suit, the swing in balances from bank credit to government paper could still be quite large."
Finally, he adds, "Our sense is that there could be many prime funds that convert to government-only funds given their clients demand for same day liquidity and stable NAVs. Indeed, converting to a government-only money fund seems to be the best strategy for money fund sponsors seeking to retain balances in the current low rate environment and with the very narrow spread between prime and government-only money fund yields. Of course, once interest rates start rising -- and the current 2-3bp spread between the 7d return on prime and government-only money funds widens -- investors may become more selective and willing to forgo some of their stable NAV preference for the higher yields in prime funds. And at that point, some of the cash that flowed into government-only funds will migrate back into prime funds, putting downward pressure on CP and CD rates."
Citi Research's Vikram Rai also examined the repercussions in his "Short Duration Strategy" commentary. "Given Fidelity's status as an industry leader, this announcement could influence other MMF managers to adopt similar strategies, especially since many more MMF managers are likely to have received similar feedback from their clients; i.e., they want access to money market mutual funds with a stable NAV that will not be subject to liquidity fees or redemption gates, which would restrict their use of these funds. The key question now on everyone's minds is if this will serve as the catalyst that will open the floodgates for large outflows from institutional prime funds. The combined AUM for all institutional prime funds is about $927 billion, and the numbers that have been bandied around by market participants with respect to the size of potential outflows range from $100 billion to $700 billion."
He continues, "We have maintained that wider credit spreads will serve as a counterbalancing force against outflows. Currently, the yield differential between institutional prime funds and institutional govt. funds is about 2-3bp. But, an increase in this spread could incentivize corporate treasurers and other investors to modify their guidelines such that they are able to invest in floating-NAV funds and take advantage of higher yields. Thus, the initial outflows from institutional prime funds will serve as part of the process that will build up to much wider credit spreads (which will in turn stanch outflows and maintain a lid on yields for credit products)."
Rai concludes, "The MMF industry is likely to undergo a slightly unsettled phase, if you will, as key players in the industry tweak their business models before they hit upon the optimum combination to navigate the post-SEC MMF world. In addition, we can expect some knee-jerk reactions on the part of smaller MMFs if they witness outflows. But, we do see a stable landscape ahead for the industry even though it may take more than a year for things to settle down."
The February issue of Crane Data's Money Fund Intelligence was sent out to subscribers Friday morning. The latest edition of our flagship monthly newsletter features the articles: "MMFs Adapting to New Regs: Move to Govt & Private Funds," about how Fidelity, Federated, and others are preparing for MMF reforms; "Basics & Regulations Focus of 5th Money Fund University," a recap of Crane's Money Fund University, with a focus on MMF reforms; and, "Fidelity Cash Reserves Going Govt; Shocking MMF World," a story about how Fidelity plans to convert its Cash Reserves prime fund to a government fund. We also updated our Money Fund Wisdom database query system with Jan. 31, 2015, performance statistics, and sent out our MFI XLS spreadsheet this morning. (MFI, MFI XLS and our Crane Index products are all available to subscribers via our Content center.) Our February Money Fund Portfolio Holdings are scheduled to go out on Tuesday, Feb. 10.
The latest MFI lead article, "MMFs Prepare for New Regs: Move to Govt & Private Funds," says, "When the largest manager of money fund assets, Fidelity, announced plans to convert its flagship Fidelity Cash Reserves, from a "prime" fund to a government fund, it sent shockwaves through the industry. (See our story at the bottom of page 1.) It is the first clear indication that the SEC 2014 reforms, particularly the rule that will require Prime funds to adopt emergency gates and fees, will indeed lead to significant outflows (as many strategists predicted) from the prime sector."
It continues, "Other fund companies are watching carefully and considering alternatives. Until now, money market watchers had assumed that institutional investors would be the most averse to a floating NAV, but clearly retail sweep money concerned about gates and fees is also now an issue. Going government is clearly the first way to opt out of prime funds, but other alternatives are also being discussed."
In our middle column, we look at the highlights from our Money Fund University conference. It reads, "Crane's 5th Annual Money Fund University is in the books, attracting nearly 100 attendees to Stamford, Conn., 2 weeks ago, for a two-day crash course in money market funds. Day 1 touched on the History of Money Funds, the Federal Reserve, ratings, interest rates, and the various securities that make up the money markets. Day 2 focused entirely on regulations as the industry's leading attorneys dove into the 2014 MMF reforms, highlighting major changes." (Note: MFI Subscribers may access the conference materials at the bottom of our "Content" page, or here.)
The article on Fidelity's Cash Reserves Going Govt says, "Fidelity announced a series of changes to its money market fund lineup last week, representing the first major strategic reorganization following the SEC's July 2014 market fund reforms. The most noteworthy feature of the partial reorganization is a move to convert several prime funds into government funds, including Fidelity's largest fund (and the largest fund in the world), the $112 billion Fidelity Cash Reserves." (See Fidelity's announcement here.)
It continues, "In a statement, Fidelity said, "Many investors have told us that they want access to money market mutual funds with a stable NAV that will not be subject to liquidity fees or redemption gates, which would restrict their use of these funds. In response to those preferences, we are announcing the first set of proposed changes to certain of our money market mutual funds, which are designed to align our product offerings to best meet investors' future needs."
Crane Data's February MFI XLS with Jan. 31, 2015, data shows total assets decreasing in January, the first drop in 6 months, down $46.6 billion to $2.603 trillion, after rising $86.2 billion in December, $21.0 billion in November, $10.2 billion in October, $27.5 billion in September, and $34 billion in August. Our broad Crane Money Fund Average 7-Day Yield and 30-Day Yield remained at 0.02%, while our Crane 100 Money Fund Index (the 100 largest taxable funds) stayed at 0.03% (7-day and 30-day). On a Gross Yield Basis (before expenses were taken out), funds averaged 0.14% (Crane MFA, up from 0.13%) and 0.17% (Crane 100, unchanged) on an annualized basis for both the 7-day and 30-day yield averages. Charged Expenses averaged 0.12% and 0.14% for the two main taxable averages, the same level as last month. The average WAMs for the Crane MFA and the Crane 100 were 41 and 45 days, respectively. The Crane MFA WAM is up 1 day from last month while the Crane 100 WAM is up 2 days from the prior month. (See our Crane Index or craneindexes.xlsx history file for more on our averages.)
In other news, the New York Fed released a "Statement Regarding Term Reverse Repurchase Agreements." It says, "As noted in the January 28, 2015, Statement Regarding Term Reverse Repurchase Agreements, the Federal Open Market Committee instructed the Open Market Trading Desk at the Federal Reserve Bank of New York to conduct a series of term RRP operations from mid-February through early March. These tests are intended to help the Desk examine how term RRP operations might work as an additional supplementary tool to help control the federal funds rate. The tests will consist of four one-week term RRP operations to take place on successive Thursdays, beginning with a $10 billion operation on February 12. The amount offered and maximum offering rate associated with each subsequent operation will be announced on or around the Monday prior to the operation. Each of these operations will be conducted from 9:30 a.m. to 10:00 a.m. (ET), and each bidder will be limited to two bids per operation. Each bid will be subject to a maximum size equal to the total amount offered in a given operation."
The Federal Reserve Bank of the New York plans to modify the process used to calculate the Federal Funds Rate and publish a new "Overnight Bank Funding Rate" early next year. In a release entitled, "Statement Regarding Planned Changes to the Calculation of the Federal ate and the Publication of an Overnight Bank Funding Rate," the NY Fed says, "The Federal Reserve Bank of New York (New York Fed) publishes the federal funds effective rate (federal funds rate) on a daily basis. This rate is calculated using data on transactions that occurred in the federal funds market on the previous day. The New York Fed plans to make an improvement to the process for calculating the federal funds rate, as described below. This change is solely intended to make the calculation process more robust, and no inferences should be drawn about the stance of monetary policy from its implementation. In addition, to increase the amount and quality of information available to the public about the overnight funding costs of depository institutions, the New York Fed is preparing to publish an additional overnight rate on its public website. This rate -- referred to as the overnight bank funding rate -- will be calculated based on both federal funds transactions and the Eurodollar transactions of U.S.-managed banking offices." We review this news and also revisit Fidelity's recent moves to change its Cash Reserves Fund to a Government money fund below.
The statement explains, "Changes to the calculation of the federal funds rate and publication of the overnight bank funding rate will be implemented after revisions to a Federal Reserve data collection are complete, which is expected within approximately one year. The New York Fed will announce an implementation date and additional information closer to the effective date of the change. In light of recent international focus on best practices for reference rates, the New York Fed reviewed the process for calculating the federal funds rate. As a result of this review, the New York Fed intends to enhance the federal funds rate calculation process by transitioning the data source from data supplied by federal funds brokers to transaction-level data collected directly from depository institutions. This Federal Reserve data collection (the FR 2420) was initiated in April 2014 and collects data on unsecured money market borrowing by depository institutions on a daily basis. These data include both trades executed through brokers and those negotiated directly between counterparties."
The New York Fed adds, "The FR 2420 report collects data on several types of unsecured borrowings by depository institutions. In the overnight tenor, these data comprise both federal funds and Eurodollar transactions, which collectively represent a substantial proportion of banks' overnight borrowings. Currently, there is little transaction-based information available to the public on broad overnight funding costs for U.S.-based banking offices. In order to provide insight into these costs, the New York Fed expects to begin publishing an overnight bank funding rate that is calculated using transactions in both federal funds and Eurodollars.... The overnight bank funding rate is expected to be published daily based on trades executed on the previous day, as reported on the FR 2420. The publication of this rate will commence after revisions to the FR 2420 collection are complete."
Wells Fargo strategist Garret Sloan says in his daily commentary that the move could make it more volatile. "Instead of utilizing quotes from brokers, the Fed will now collect actual transaction level data directly from banks that execute Fed funds trades, including direct bank-to-bank transactions that do not execute through brokers. The data is likely to capture transactions that are meant to be kept quiet. In other words, the data should capture trades that in the past could have tipped the market to funding stresses. The result may be that Fed funds effective rates, in general, will become more volatile going forward. For now, with Fed funds essentially existing as an FHLB-driven market, the nuances of the Fed funds rate may seem less important. What we do learn from this revised calculation method is that the Fed is not abandoning the Fed funds rate as a primary benchmark for conducting monetary policy."
He adds, "While the Fed is not abandoning the Fed funds rate, it is expanding the rates it uses to calculate actual bank funding costs. One of the issues with the Fed funds market is that it only looks at funding levels transacted in the U.S. between banks. The Fed's new data set, the Overnight Bank Deposit Rate will incorporate all Fed funds transaction data plus all other overnight unsecured funding that banks receive from other sources, including money market funds and other large sources of overnight cash. The broader Overnight Bank Deposit Rate will be an interesting supplement to measure the perceived funding nuances between inter-bank and external bank funding sources."
In other news, reaction continues from Fidelity's plan to convert 3 Prime money market funds to Government funds, including the $114 billion Fidelity Cash Reserves fund. (See our Jan. 30 "News", "Fidelity Announces Major Changes to MMFs; Staying Stable, Going Govt.") Bloomberg writes, "Fidelity Changes Largest Money Fund to Buy Government Debt. The piece provides a brief recap and quotes our own Peter Crane as saying, "The large retail funds all have to be asking themselves if they have to follow suit.... The big question is whether the government space is big enough to hold all of that money."
JP Morgan's Short Duration Strategy team also commented on the news. They write, "This is the first major strategic announcement that we are aware of from a MMF family since the new SEC rules were finalized in July 2014.... We believe the goal of these moves is to ensure that all existing shareholders will be able to continue to participate in stable NAV funds that are not subject to redemption restrictions (i.e., government MMFs).... For retail investors, which the new SEC rules define as "natural persons," it is quite possible many of these retail shareholders will redeem and migrate away from government MMFs."
JPM adds, "The new SEC rules allow them to continue to invest in stable NAV prime MMFs, a product very similar to what they currently hold. For institutional investors, they are given a choice of staying in the government MMFs or reallocating into a floating NAV prime MMF or some other form of investment, as the new SEC rules exclude non-natural persons from participating in stable NAV prime MMFs." On the likelihood of shareholders leaving the transitioning funds, they write, "[W]hile we suspect many of the affected shareholders will ultimately re-align with prime funds, it is not clear how quickly this might happen. The current low level of money market yields doesn't offer much incentive to shift quickly, but the onset of higher rates later this year or in 2016 might change that.... There are a wide range of business models across the MMF segment of the asset management industry, and while some may follow Fidelity's lead, others will chart their own route with their own timetables."
Below, we excerpt the second half of our article, "Short Now Big at PIMCO: Talking w/Schneider & Reisz," which appeared in the inaugural issue of Crane Data's new Bond Fund Intelligence publication. (See our Jan. 27 News, which features Part I of the interview here or see the January issue of BFI.) BFI: Is the ultra-short space getting more crowded? Schneider: The space is becoming more crowded because there's more interest from the investor side. The reality is, managing a 2a-7 fund and managing in the short-term space are two entirely different propositions. The reason is because you have to be thinking about liquidity, not just simply from a duration or interest rate perspective, but also in terms of market risk and market orientation.
That requires managers to focus on what bonds are liquid in times of defense when clients need it. Building an infrastructure that caters to that is paramount. We've been doing it for 40 years. It's been tried and tested through the 2008 financial crisis and more recently, the European crisis. For us, the number one focal point is looking at the funding element and the financing element. This is sort of the barometer of the overall health of the front end market.... You want to be opportunistic and sell rich bonds when you can and buy cheap bonds when you can. That's the beauty of active management as opposed to buying an asset and holding it to maturity.
BFI: What is your strategy in the short-term space? Schneider: At PIMCO, we focus on 4 things -- liquidity, capital preservation, credit risk, and macroeconomic conditions. What differentiates us is our broad and deep team of portfolio managers and analysts and our top-down macroeconomic process that drives portfolio construction that other managers may not have. For example, our resources are extensive. We have over 60 credit analysts worldwide who focus on individual credits from the bottom up -- a robust platform that strives to add value and protect the portfolio. In addition, our macroeconomic process is a critical component of our portfolio management.
Reisz: Another important consideration in constructing these portfolios is our emphasis on the key objectives of principal preservation and liquidity. These are cash alternative portfolios where investors aren't looking for a surprise -- that is what we always keep in mind, so our strategy is to make sure that these portfolios are well diversified and that they maintain a high level of liquidity.
BFI: How are regulations impacting you? Schneider: Overall, supply has decreased for a variety of reasons. What we focus on at PIMCO is relative value opportunities. Those have really been attractive to us for a variety of reasons. We've used our credit sources, our structured products resources, and a variety of different avenues to look beyond the constraints of a typical money market instrument. We've been active in using our resources to do reverse inquiries with corporate issuers, looking at buying low volatility assets, around the world, through avenues that typically haven't had their stones turned over in many years. We were pioneers in this and we will continue to look for ways to actively pursue better risk adjusted investments.
Reisz: That's why active management is important; it helps us navigate supply changes or rising rates. It also provides the flexibility to invest in various sectors, in fixed vs. floating rate by utilizing a broad and diverse toolkit.
BFI: Do you see assets flowing in from money funds or longer-term bond funds? Schneider: This is an evolutionary process. We don't expect everyone to go stage left all at once. This has been a bespoke, individual dilemma for institutional and retail investors. We've seen interest evolve over the past three years and it's going to continue to evolve, precipitated by changes in the regulatory environment over the next year or two. Investors need to be cognizant of that and consider new avenues.
Reisz: Money markets will still play an important role within a liquidity strategy, but investors will probably start to focus on how to tier that liquidity. How much should I allocate to money markets? How much should I allocate to short duration strategies that might earn a little more than money markets? That's why we've developed a broad range of strategies, to make sure we're covering the different investor profiles and needs.
BFI: What is your outlook for this space? Schneider: Even in an environment where interest rates may increase, ultra short strategies have the potential to perform well on a risk adjusted basis. Supply constraints are going to continue to limit the ability to generate attractive yield in money market funds. Investors want not only yield, they also want to be more nuanced in how they choose strategies to manage their liquidity, and that is where short term strategies may be beneficial. Our focus is on the middle of 2015 for the initial rate hike, but we believe the Fed is going to be deliberate in how it continues to tighten. We may not see a hike at every meeting or even at every other meeting -- it will be as the data permits.
Note: Crane Data recently launched Bond Fund Intelligence to track the bond fund marketplace with a focus on the ultra-short segment -- see our Dec. 23 News "Crane Data Launches Bond Fund Intelligence, Focus on Ultra-Shorts". Contact us if you'd like to see the January or our pending February issue, which will feature an interview with Columbia's ultra-short bond fund team.
Four of the money fund industry's leading industry attorneys took to the dais on day 2 of Crane's 5th Annual Money Fund University a week-and-a-half ago in Stamford, Conn., to talk about regulations -- primarily the reforms adopted by the Securities & Exchange Commission in July 2014. (Three of the four will also be presenting tomorrow at ICI's one-day seminar, "Will You Be Ready? Implementing the New Money Market Fund Rules".) In the opening MFU session, Joan Ohlbaum Swirsky, Counsel at Stradley Ronon and author of the book, "The Guide to Rule 2a-7: A Map Through the Maze for the Money Market Professional," and John Hunt, Partner at Nutter, McLennan & Fish, set the stage by discussing the history and particulars of 2a-7 and touched on the first round of reforms in 2010. During the two sessions that followed, Stephen Keen, Counsel, Reed Smith, and Jack Murphy, Partner, Dechert LLP, dove into the 2014 reforms, highlighting the major changes and the questions that remain unanswered. Below, we excerpt from these sessions. (Note: For more on Fidelity's Major Money Fund Changes, see yesterday's "News and see J.P. Morgan Securities' update, "Fidelity announces major changes to its MMF lineup".)
Explaining the long road to reform, Keen said, "First, I want to talk about how we got here and the fact that we're still somewhat on the road. In September 2008, the financial crisis hit and within 6 months, ICI had established a working group, which came up with a set of reforms that [were] basically the genesis of the 2010 amendments. That was the first step, but there was more to come, and there was a long process of getting that more worked out. It culminated in July 2014 with the adoption of new reforms. But there's still a little unfinished business. There are a lot of unanswered questions about the reforms; ICI and SIFMA have sent the SEC a set of frequently asked questions to basically see if we can some interpretive responses from them. (This Q&A has not been made public yet). Also, the SEC has proposed additional amendments to get rid of credit ratings as required by Dodd-Frank, so those ... are going to change."
Keen explained, "What happened was we invented new types of money market funds. We've talked about prime, government, tax-exempt -- those are all categories that came from people like Peter [Crane], who started to classify funds. But those are not technically legal terms -- until now. The rule now defines what a government money market fund is, what a retail money market fund is, and then anything that isn't those things is going to have a fluctuating NAV, so we are going to call that an FNAV fund. Only government and retail will have stable values, and only retail and FNAV funds are required to have fees and gates. Then there are a set of general reforms that apply to all 3 categories, although at different levels of impact, depending on the fund."
On FNAV funds, Keen said, "Let's start off with the FNAV funds. This is a money market fund that unlike all money market funds today, cannot use the amortized cost method or penny rounding to stabilize its NAV. Now the caveat for that is, you can still use amortized cost for securities with remaining maturities of 60 days or less. The other thing that's different is they have to round not to the nearest penny but to the nearest basis point; the fourth digit in a one dollar price. This is 10 times the accuracy that's required of a mutual fund. Government funds and retail funds can still penny round but FNAV funds cannot -- they have to add these extra digits and that's intended to make their NAV move. One of the problems with FNAV was the fact that you have to track the changes in the NAV for accounting and tax purposes. What the SEC did in connection with this was coordinate with Treasury and IRS to eliminate some of those problems. The IRS also adopted a provision that exempts these types of funds from what are called wash sale rules."
Keen added. "Retail funds sustain their stable NAV, but they restrict its beneficial owners to natural persons.... Retail funds have to have procedures that are reasonably designed to keep your beneficial owner as natural persons. This is one of the things that we've asked the SEC to give us more insight on." Keen continued, "If you have non-natural beneficial owners, then you're going to have a fluctuating NAV. The simple answer so far appears to be that it's beneficially owned by a natural person if you have a social security number -- only natural persons have social security numbers. An estate account should be beneficially owned by a natural person. Only people retire, only people go to college, only people get sick, so retirement plans, college savings plans, health savings plans should all qualify."
Murphy added, "The last thing you want here is to add any ambiguity. It would be great if the SEC would draw lines so that everyone is on the same page. If not, then the industry will have to try to draw its own lines." Keen commented, "For government funds, it's a very simple requirement -- 99.5% of your total assets have to be in government securities or repurchase agreements backed solely by government securities, or cash. If you meet these qualifications you can maintain stable NAV and you have no restrictions on whom your investors can be." Murphy added, "Historically, government funds have had to have at least 80% in government securities."
On Fees and Gates, Keen explained, "With government funds, you're also not going to be subject to fees and gates. So now we are going to talk about retail and FNAV funds [which are subject to gates and fees]. The board has an option to impose a liquidity fee or a gate on redemptions if weekly liquid assets are below 30%. The liquidity fee can't be higher than 2%; the redemptions suspension cannot be for more than 10 days. You don't have to disclose the liquidity fee on the fee table because it's an emergency measure, so it's not a normal cost. And you have to remove it if you get back over 30%. When you're back over 30% it has to come off the next day. There's also a default liquidity fee if you are below 10% weekly liquid assets and the default fee is 1%. It's a default in the sense that if the board doesn't meet to impose a different liquidity fee, or impose a gate, or decide not to do anything even though the fund is down to that level of weekly liquid assets, then it will take effect. Basically, the board still has the ability to call off any fee or gate. It's not required to ever put it on. At 30%, it's totally optional; at 10%, unless you act, you are going to have to put it in play."
Keen added, "The point I keep making on this is, no one is going to operate at 30% weekly liquid assets -- they are going to operate at 40%, or 35%. They are going to have a margin for error. The real question is: What's the reason [you breached 30%]? If the reason is you have a defaulted security in the portfolio, then these will be tools to deal with that circumstance. What will drive the decision is not the fact that you're at 22% weekly liquid assets, or 8%, or whatever, it'll be that you have a defaulted security in the fund. Or the market has melted down and there's no liquidity. Those are the circumstances that you need to keep your eye on because that's going to drive what the fund and board should do."
Murphy added, "The notion is: if you are going to have a run on the bank, how do you stop it? You close the doors of the bank. How do you stop a run on the money fund -- you close the doors. Only, funds have never had the authority to do this. No one knows if this is going to be a nuclear event."
They then discussed Disclosure Requirements. Keen said, "You're going to need to report your weekly liquid assets everyday on the web site." Murphy commented, "We're seeing funds either putting in place or thinking about putting in place procedures like that, whereby, at a certain level, notice is given to the Chairman of the Board before it's posted on the web site. The SEC came up with a new form ... Form N-CR would be required to be filed upon certain material events -- a default or event of insolvency, a provision of financial support by the sponsor, a stable NAV fund that's shadow price drops below 99.75 cents, or weekly liquid assets that drop below 10% at the end of a business day. Also, any time a fund imposes or removes a liquidity fee or gate. This is the first thing you'll have to comply with (July 2015)."
Murphy continued, "Currently, the fund has to disclose its month-end WAM and portfolio holdings as of the end of each month. This has been amended. The fund will now be required to disclose its WAL, the maturity date for each portfolio holdings, as well as each holding's fair value. With respect to daily website reporting, funds are going to be required to disclose for the end of each business day during the preceding 6 months the percentage of total assets in daily and weekly liquid assets, net inflows and outflows, and the shadow NAV rounded to the nearest basis point.... You need to post 6 months' worth of data as of April 14, 2016, so you need to start thinking about this." In closing, Keen commented, "It's been amazing to me that almost $3 trillion has stayed in the funds with effectively no return. That testifies to the need for money market funds."
The first major strategic shift following the Security and Exchange Commission's money market fund reform occurred Friday as the world's largest manager of money funds, Fidelity, announced major changes to its money market fund lineup. The shifts are to comply with pending reforms and to meet investor needs, with the most noteworthy being a move to convert some of its prime funds into government funds, including the largest money market fund in the world, the $114 billion Fidelity Cash Reserves. (See Fidelity Cash Reserves' Prospectus Supplement filing here.) Nancy Prior, President of Fidelity's Fixed Income Division, tells Crane Data, "We're fully committed to the money market fund business.... We're going to have a robust product lineup covering all of the categories, including retail and institutional prime and municipal funds, along with government and Treasury funds, because we want to make sure we can meet all of our customers' investment needs. But we're making these changes now in response to the preferences that we've heard back from several segments of our customer base that would like to continue to have a money market fund with a stable NAV and without gates and fees." (See also Fidelity's "Update on money market fund regulations" and "Fidelity Money Market Mutual Fund Changes.")
Prior announced the 4 key changes as part of "Phase 1" of its changes to its money fund lineup. The first is to amend the investment policies their government and U.S. Treasury money market mutual funds to reflect that these funds already meet the new SEC requirement to invest at least 99.5% of their assets in cash, government securities, and/or repurchase agreements that are fully collateralized.
Second, Fidelity plans to convert several of its prime money market mutual funds to government money market mutual funds. Specifically, the Fidelity Cash Reserves Fund will be converted into the Fidelity Government Cash Reserves Fund; the FMMT Retirement Money Market Portfolio will be converted to the FMMT Retirement Government Money Market Portfolio II, and the VIP Money Market Portfolio will be converted to the VIP Government Money Market Portfolio. All are subject to shareholder approvals via a March proxy vote.
Third, the company is proposing to merge several funds that have similar investment strategies. The Fidelity Treasury Money Market Fund (U.S. Treasury) will be merged into the CMF Treasury Fund to form the Fidelity Treasury Money Market Fund (U.S. Treasury). The CMF Government Fund (Government) will be merged into the Fidelity Government Money Market Fund to form the Fidelity Government Money Market Fund (Government). The AMT Tax-Free Money Fund (Municipal) will be merged into the CMF Tax-Exempt Fund to form the Fidelity Tax-Exempt Money Market Fund (Municipal). No shareholder action is required and these changes will take place in the first quarter.
The following mergers will require shareholder approval, via a proxy vote in March. The Select Money Market Fund (Prime) will be merged with the Fidelity Money Market Fund to form the Fidelity Money Market Fund (Prime); the CMF Prime Fund (Prime) and the U.S. Government Reserves Fund (Government) will be merged into the Fidelity Government Money Market Fund to form the Fidelity Government Money Market Fund (Government). There will be some name changes as a result of these changes, which will be announced at a later date.
"We expect, assuming we get the shareholder approval, to implement these mergers throughout the remainder of 2015," said Prior. "Then, during 2016 we'll focus on the retail/institutional definition and the other structural reforms that are required to be implemented."
A statement sent to Crane Data said, "At Fidelity, we remain committed to offering a variety of investment options and will continue to have a robust product lineup that includes retail and institutional prime and municipal money market mutual funds, along with U.S. Treasury and government money market mutual funds. Many investors have told us that they want access to money market mutual funds with a stable NAV that will not be subject to liquidity fees or redemption gates, which would restrict their use of these funds. In response to those preferences, we are announcing the first set of proposed changes to certain of our money market mutual funds, which are designed to align our product offerings to best meet investors' future needs."
They added, "We will continue to listen to our investors as we approach the final date for money market mutual fund regulatory implementation in October 2016. In the future, we expect to announce which money market mutual funds will be classified as retail funds, and which will be considered institutional funds under the SEC's new rules. As market conditions and investor preferences evolve, we will continue to review our money market mutual fund lineup to ensure that we are meeting investors' needs."
Finally, Fidelity commented, "We are well-prepared for the new rules. With this initial set of proposed changes, we are evolving our product offerings and fund operations to comply with these rules and meet investor needs. We know that money market mutual funds are very important to many investors and these funds will continue to be an integral part of our business."
Also, of note, Fidelity posted the results of a survey designed to gauge the attitudes of institutional clients on the subject. Attendees at Fidelity's Liquidity Council events in Houston and New York revealed that "over 50% of respondents are unsure if they will continue to utilize Prime money market mutual funds when these funds move to a floating NAV, subject to fees and gates." Also, "nearly 100% of those surveyed indicated that having same-day liquidity will be "extremely important" when deciding if they will continue to utilize a Prime (general-purpose) money market fund." Finally, the survey said that "over 60% of respondents recognized the need to update their Investment policy statement in 2015 to accommodate 2a-7 changes."