At last week's New York Cash Exchange conference, sponsored by the Treasury Management Association of New York, there were a number of excellent money market fund-related sessions, including the show-opening, "Money Fund Rates and Regulations Roundtable," moderated by Crane Data's Pete Crane and featuring Craig Ferrero, Managing Director, JP Morgan Asset Management, Ronald Hill, Director, BlackRock, and Andrew Hollenhorst, Fixed Income Strategist at Citi. Crane summed up the current cash landscape, and Prime Institutional money funds' place in it, with a quote from a recent film. "It's like the line from the movie 'Argo' where they say, 'We have nothing but bad options. But this is the best bad option, by far.' That's what we are going to be seeking out this morning -- the best bad option for your cash."
The Roundtable began with macro analysis of the market by Hollenhorst, who focused on two key issues -- interest rates and Federal Reserve's Overnight Reverse Repo Program. "The first order of importance for any front end investor right now is what the Fed is going to do. The issue is not just when the fed will hike rates, but also how the Fed will hike rates," said Hollenhorst. When the Fed does hike rates, it not only gets rates off zero, "it opens up the possibility for fee rebates to go away in some of the money funds, it opens up the possibility for a little bit more pricing power on the part of commercial paper issuers, and you get those spreads opening up. That's when you could actually see cash migrate back into a prime product," he explains.
The most important tool in the Fed's arsenal is the Overnight Reverse Repo Program. Right now it's capped at $300 billion, but Hollenhorst expects that to increase. If the Fed does not increase the size of that facility, the expected demand for government funds due to money market reform could outweigh the available supply, says Hollenhorst. "The Fed needs to respond by increasing the size of the RRP. My view is, when the Fed lifts off rates they will probably have that facility operating around $1T in total size. They might do some of that in term, they might do some of that in overnight repo, but they need to have significant size in the facility to make sure that they floor rates."
Hollenhorst adds, "From the perspective of those operating money funds, it's created a major wildcard in that we don't how large it's going to be and how long it's going to be available. The Fed has continued to indicate that this is something that's going to be around for a temporary period of time. My view is that the temporary period of time is probably many years to come given how large the balance sheet is and how long it takes to take that down." T-bills and Agency supply will be less of a factor, he said. "The reason I emphasize that less is because there's not that much room for expansion in either space. Fannie Mae and Freddie Mac are actively reducing the size of their balance sheets, so if anything we should have a continued reduction in Agency discount notes and other short Agency paper. There's not a lot of new supply there."
On T-Bills, he said, "The deficit has contracted from $1 trillion to $500 billion, which is great news for the U.S. fiscal picture but bad news for those who are investors in T-Bills. Recently, Treasury indicated that they are increasing the supply of Bills, so we're actually getting some positive Bill issuance right now. But that's because Treasury wants to hold a larger cash balance going forward so they are going to have to keep a little more cash as a reserve. That's helpful for the market, but it's not clear that they'll do a lot more than that."
Hill said BlackRock has spent a lot of time talking to clients about money fund reform. "The conversations range anywhere from what our fund lineup is going to look like post-reforms to what we're doing today. We spend a lot of our time with our clients, thinking about how these changes are affecting them and how we can develop a product that keeps everything less disruptive."
One of the new products that BlackRock is developing is a 7-day maximum maturity fund. "We're probably an outlier in terms of why we thought a 7-day fund fit into the new world, and a lot of this has been growing through the money market reform discussions. One thing that people have gotten comfortable with is actually the floating NAV, and one thing that we continue to hear concerns about is fees and gates. So there's a lot of discussion about how do you manage a fund to minimize the NAV volatility but also provide some relative assurances that you decrease the likelihood of fees and gates ever being implemented into a fund. The reason we thought the 7 day provided some advantage over a longer term max maturity fund is that you would be able to remove the concerns related to liquidity. Thinking about it from an investment perspective, we thought that a 7-day max maturity fund would be beneficial to the market. In a rising rate environment, a shorter maturity fund is going to recapture rates quicker when the Fed begins to tighten monetary policy."
Ferrero concurred. "We actually launched our [Current Yield, 10 day maximum WAM] fund a few years ago in anticipation of this rising rate environment, so it had nothing to do with money market fund reform. Hopefully, as we start to get this rising rate environment, it might be of interest to some clients." Ferrero also agreed with Hill that clients are getting more comfortable with the floating NAV. "I have an excel spreadsheet that tracks the shadow NAV of our Prime MMF out to 4 decimals--it's actually comical how little it moves day to day. Every day, literally for the last three years, it's been either 1.0001 or 1.0000. We're talking about such a minimal move."
On gates and fees, Ferrero said money fund providers will try hard not to drop a gate if the liquidity dips just below 30%. Crane agreed, "If you look at the scenarios that might trigger a gate or a fee -- nobody is going to implement a gate and fee for a minor breach." It would take something major like a default, like Lehman Brothers, or a systematic meltdown, said Crane.
The panelists agreed that while the idea of gates and fees may be a turn off for investors initially, their attitude might change once spreads widen. Said Ferrero, "It's easy to say in this rate environment, 'I don't want to deal with gates and fees and floating NAV because spreads between Prime and Govies is single digits.' If we get the two rates hikes by the end of the years, the effective Fed Funds rate is going to be in the low 60s -- some prime funds are probably going to be right around that range. If all continues to move along as expected, we're probably expecting another 2 or 3 rate hikes next year before the reforms. So Prime could realistically be at 1.00 to 1.25%. Because a lot of money will be shifting to 'Govie' funds, the spreads are not going to be 10 basis points, it's probably going to be 30, 40, maybe 50 basis points. Is that a meaningful enough difference for corporate investors?"
Ferrero continued, "Back to your joke earlier that money funds are the lesser of two evils -- the question is, where do you go with this money?" The hope is that corporate investors get comfortable with their fund providers, comfortable with the floating NAV, and comfortable knowing they're not going to put down gate and fee for something minor he told the NY Cash crowd.
Finally, the conversation shifted to alternatives, primarily separate accounts and private money funds. Ferrero said many clients have expressed interest in separately managed accounts. "They're sitting on more cash than ever and they're tired of these yields." J.P. Morgan has about $100 billion in separately managed accounts in a range of strategies, from those that mirror existing money funds to those that go a step beyond money funds. The latter is where they are seeing the bulk of the interest from corporate investors. There's a significant yield pick up over Prime MMFs, from 30 to 50 basis points, "and you're not extending out too far where you have to worry about this rising rate environment."
BlackRock is seeing similar interest in SMAs, said Hill. Separate accounts have been top of mind the last 2 or 3 years for several reasons -- the extremely low rates, large cash balances, and the control investors have over the portfolio. "It's their ability to exclude certain investment, to add certain investments, to change when they have cash and liquidity needs.... They have excess cash and there's a lot of pain in earning zero when you don't have to. In a separately managed account, they're able to add yield in a very risk controlled way."
There was also a lot of interest in and a lot of discussion at the NYCE about "Private Funds," both inside and outside of the sessions. Ferrero said that private placement funds are permitted by Rule 3c-7 and are exempt from Rule 2a-7. One of the differences between 3c-7 funds and 2a-7 funds is the number of investors are limited and it can't be mass marketed to retail investors, only institutional investors, he said. Look for more coverage of New York Cash and Private funds in the pending June issue of Money Fund Intelligence.
