New rules, same role
The new regulations for money funds don't change their value proposition.
Investors will have the ultimate say about the impact of the SEC’s new money market fund amendments released last month. We think their response will be positive. Why? Because the core attributes that make money funds popular remain, and in most cases are enhanced.
Remember “fees and gates?” The recent removal of redemption gates and the link between the weekly liquid asset threshold and potential fees (both levied by the 2014 “reforms”) will improve all prime and municipal investors’ access to their cash.
On the retail side, boards will retain the option to impose fees to maintain the integrity of the stable NAV—though we examined past periods of market stress and did not find any times where we would have implemented a fee. That confidence stems from our policy to hold high level of daily and weekly liquid assets. The 2014 amendments required minimum levels of 10% and 30%, respectively, of a fund’s total assets, but we always strove to exceed them. We play it safe because that’s what investors look for in this asset class. The new thresholds of 25% and 50% will probably cost investors in prime money funds some yield (we estimate a few basis points). But their value proposition won’t change as they likely will continue to offer a yield spread over government funds. In net, we expect increased use of retail prime and muni money market funds, in particular by sweep accounts that once used them extensively.
Remember when interest rates were near zero? It seems like a decade ago. But during that period, the SEC asked the industry for proposals on how to handle negative rates, even though the Federal Reserve repeatedly said it opposed implementing them. The SEC listened to us, offering two solutions for running a stable NAV fund if rates ever fall below zero: a fund could float its NAV or opt to maintain a stable NAV by reducing the number of shares outstanding through a “reverse distribution mechanism.”
That takes us to the new mandatory liquidity fee requirement (different than the discretionary fee outlined above). This rule requires institutional prime and institutional tax-exempt money market funds to impose fees when daily net redemptions exceed 5% of the fund’s net assets, unless the liquidity cost of the redemptions are determined to be de minimis (defined as less than 1 basis point). If you recall, institutional versions of prime and tax-free money funds are the same ones the SEC forced to float their NAVs in 2014. This is why we are not overly concerned. We don’t think the institutional investors who remained in (or later returned to) them will exit now because of the potential of a fee that likely to be rare and measured in basis points. They are there for the potential of yield spreads over government money funds.
While the new amendments largely benefit money funds, there are now a host of other cash management vehicles not subject to them: private funds, state/local government pools, money market collective investment trusts (CITs) and the like. Industry-wide, their use has increased, and we expect that trend to continue.
In the end, we are confident the role that money market funds play in cash management will remain attractive for investors.
The near future for the liquidity market got a boost when the Federal Reserve hiked rates once again last week. FOMC voters resumed their tightening cycle by raising the fed funds target range by 25 basis points to a 22-year high of 5.25-50% and leaving the door open for at least one more. Futures contracts are all over the place at present, but the simple math is that the remarkable run for cash managers continues. The longer the Fed fights inflation through rate hikes and quantitative tightening, the higher the yield should be on the asset class that only a year and a half ago was yielding in the single digits. And we don’t expect the path down will be nearly as steep. When the Fed finally decides to stop hiking, it likely will keep rate at that lofty level for at least the rest of this year. Visualize a plateau, not a peak, with investors basking in the strong returns. This yield curve is capturing this optimism, coaxing us to extend our Weighted Average Maturity by five days to 30-40 days to capture the attractive rates.