In their latest "Overview, Strategy, and Outlook" Wells Fargo Advantage Funds' Money Market Funds team offered a nice recap of Crane's 7th Annual Money Fund Symposium last month in Minneapolis, focusing on the major themes that came out of the conference -- Fed RRP, Supply, Fund Flows, and Market Liquidity. We also report on a new paper from Fitch Ratings called "Cash Management: The World Has Changed, Your Investment Guidelines Should, Too," which highlights the importance of reviewing investment guidelines, particularly the use of ratings agencies. The Wells team, led by Jeff Weaver, Head of Money Funds and Short Duration Strategies, writes, "In late June, more than 500 industry professionals descended on Minneapolis for the seventh annual Money Fund Symposium, sponsored by Crane Data. This is the largest conference aimed at money market fund portfolio managers, credit analysts, investors, servicers, issuers of money market securities, and others involved in the money market fund industry."
Wells tells us, "As we noted in 2014, the common takeaway from last year's conference was an underlying current of frustration over continued low interest rates, a lack of conclusion to the regulatory reform process, and the lack of supply of investable assets. This year, the atmosphere seemed to be more workmanlike, for lack of a better term, because many issues seemed to have been resolved. Now that we're past the biggest hurdle -- issuance of the new 2a-7 rules for money market funds from the Securities and Exchange Commission -- the focus is on compliance and implementation; there were several panels dealing with these subjects alone. Also different from last year, we are on the precipice of the U.S. Federal Reserve (Fed) beginning to tighten and normalize interest rates; this is a welcome development to yield-starved investors, and the prospect of ending this six-and-a-half-year-long drought left some giddy with anticipation."
They touched on the major themes from Symposium, writing, "Two themes remained in common from last year and will likely be the subject of much discussion in the future as well: the role of the Fed's reverse repurchase agreement (RRP) facility and the ongoing and lamentable lack of supply. In reality, the two may remain linked for some time because there is no general consensus on how long the facility will remain in place or how large it will be. Opinions on the subject range from it becoming a permanent, full-allotment facility that is prepared to absorb any excess demand for government securities to the opposite extreme of remaining capped at its current size and being wound down shortly after the Fed starts its tightening cycle. The actual outcome probably lies somewhere in between the two scenarios, with the Fed lifting the cap to facilitate lift-off, providing abundant liquidity to ensure rates behave as it intends, and then winding down the facility over time."
Further, Wells says, "And two new themes emerged: the size of funds flowing from the prime and banking sectors into the government sector and what that would do to yields and an emerging lack of liquidity in some markets due to regulatory reform and demand for government instruments. The size and timing of cash flows to government funds depends on many factors, not the least of which are the overall level of interest rates and the comfort investors have with not only a variable net asset value but also the concept of fees and gates and when, or even if, they would be imposed. Liquidity, or the lack thereof, will also bear ongoing scrutiny, as it, too, will be affected not only by the size of cash flows to government funds but also by global issues that spur a flight to quality or affect the relative attractiveness of these securities to investors in countries where securities trade at negative rates. To the extent that those pressures ease, there may be some increase in liquidity."
WAMs were also discussed. Wells comments, "One of the many topics covered at the Crane conference was that prime money market fund portfolios continued to shorten their weighted average maturities (WAM). According to Crane Data, the WAM of institutional prime funds dropped from 38 days at the end of March to 34 days in June. This decline seems partially related to the projection of future Federal Open Market Committee (FOMC) activity and the risk premium being built into the market for future rate hikes. While the overall tone of the Fed's statement at the conclusion of its June meeting was a bit dovish, it is the near-term expectations of a Fed in play that has moved some money market rates."
Finally, they add, "The shortening of WAMs has prompted issuers to react by increasing yields (and spreads) in an effort to obtain longer term funding for liability management and regulatory reasons. It is not our strategy to position our portfolios to time possible interest-rate changes; rather, we focus on the goal of being adequately compensated for investments in any tenor we select. Consequently, our focus on preservation of capital by investing in high-quality securities and maintaining a high degree of liquidity is unchanged. We believe we are properly positioned to adjust quickly to changing market conditions as well as maintain our commitment to our twin objectives of liquidity and stability of principal."
The Fitch paper looks at investment guidelines and the use of ratings. It says, "Treasurers and cash managers face a daunting set of challenges due to post-crisis regulatory and market changes. They need to not only understand the impact of these challenges, but also to evolve by undertaking a strategic re-assessment of how they manage cash and updating their investment guidelines accordingly. As corporate treasurers update their firms' investment guidelines to reflect the new realities of money fund reform, Basel III, and cash segmentation, the use of ratings in the investment policy also warrants a review. Best practices at industry leaders dictate an approach that takes into account all of the 'big three' global rating agencies (Fitch Ratings, S&P, and Moody's). Legacy investment policies that only rely on one or two rating agencies are out of sync with the market and restrict cash managers from accessing certain segments of the markets. The use of credit opinions from all three agencies to inform investment decisions is the norm for sophisticated financial players."
Fitch adds, "The financial crisis fostered major changes in rating coverage by the three major agencies. Now, there is a relatively wide variation of coverage between the agencies in the various segments of the fixed-income market. Banks and Corporates increasingly carry ratings from two of the three global rating agencies. Analysis shows that since 2009, rating coverage of money market funds also has changed considerably. Moody's and S&P's coverage of money funds has declined. During the same period, Fitch Ratings has substantially increased its rating coverage of money market funds. High-quality money market tranches of U.S. asset-backed securities are another example. 55% of this sector is rated by Fitch and one other rating agency. Therefore, if a corporation's policy excludes Fitch Ratings from their investment guidelines, that investor stands to miss out on a large portion of that market."
Fitch concludes, "As asset managers develop new liquidity products like short term bond funds and private money funds, ratings will be key to these new funds given their lightly regulated nature compared to money funds. Rating coverage of these products may vary by agency. Treasurers should ensure their investment guidelines do not restrict them from evaluating new cash strategies that may be appropriate for their firm's liquidity profile.... Treasury management best practices call for a senior-level review of investment policies on a regular basis, generally annually. The advent of money fund reform combined with other regulatory and market changes makes these reviews -- done in a thoughtful, strategic way -- imperative."
