First American Funds posted a recent "Quarterly Portfolio Manager Commentary." It tells us, "One year post-reform, the First American Institutional Prime Obligations Fund remains a much smaller fund in a much smaller universe. However, shareholders are adjusting well to the new money market landscape and the First American Institutional Prime Obligations Fund has found a solid shareholder base. With comfort around the fund's base size, management was able to invest accordingly, seeking to best take advantage of the investment environment." We review this, as well as a recent Federated webinar, below.
First American explains, "The fund continued to ladder fixed-rate securities in the 60- to 90-day range and six- to nine-month floating-rate instruments. The fund was able to benefit from elevated London Interbank Offered Rate (LIBOR) levels relative to Repo and Treasury/agency products to achieve higher yields. However, the reform-influenced demand dislocations that widened credit spreads early in the year have dissipated, as issuers found the necessary funding outlets. This tempered the ability of prime assets to outperform other assets classes by the wide margins experienced early in the year."
They write, "However, by the end of the third quarter, three-month LIBOR rose to 1.334% and one-month LIBOR rose to 1.232% in response to expected Fed tightening. As the quarter progressed with the credit environment stable and the impacts of money market fund reform behind us, our main investment objective was to continue to enhance portfolio yield while judiciously extending the portfolio weighted average maturity (WAM) and weighted average life (WAL) in ways that minimized potential net asset value (NAV) volatility based on our credit, economic and interest rate outlook."
The quarterly continues, "As we expected, government funds continued to hold the majority of cash that migrated as a result of money market fund reform. Yield compression in agency products persisted as basic supply and demand dynamics impacted prices. The Fed's Reverse Repo Program (RRP) remained an important outlet for the influx of cash and a mechanism for rate control. We continued the purchase of Treasury and agency securities with maturities as long as two years.... We also capitalized on opportunities to purchase floating-rate securities, maturing well into 2019. We believe that floating-rate securities will perform well.... We will seek to add value and continue to employ this strategy as the market and portfolio metrics allow."
First American's update also says, "Municipal market conditions including heavy reinvestment needs from bond coupons and maturities, a relatively flat yield curve and rich valuations encouraged short term bond funds and separately managed accounts to become bigger players in the variable-rate demand note (VRDN) market. This additional demand from non-traditional VRDN buyers suppressed SIFMA resets for the majority of the period. Note issuance increased significantly later in the quarter with several large municipalities accessing the market. While these notes offered incrementally higher yields, portfolio management was reluctant to extend the fund's WAM as we expect VRDN's to outperform over a longer time horizon."
It adds, "In the coming quarters, we anticipate yields on non-government debt to remain elevated relative to government securities but suspect the term premiums available during reform are gone. Even with some of the yield benefits fading, we believe both the institutional and retail prime obligations funds remain attractive short-term investment options for investors seeking higher yields on cash positions while still assuming minimal credit risk. Yields in the agency and Treasury space will remain influenced by Fed policy as well as the strong demand from investors in this space. We will continue to seek opportunities -- in all asset classes -- that arise from market volatility based on domestic and global economic data and Fed rate expectations."
In other news, Federated Investors hosted its latest "Quarterly Money Market Outlook Webcast" last week. Senior VP Brian Ronayne reviews recent money fund growth then asks, "What is the engine driving this impressive asset growth in the government and prime sectors? To answer that question, you need to look no further than the competitive net yields on prime, government, and tax-free funds compared to their main competition ... banks. [T]here [is]currently more than $10 trillion sitting in MMDA accounts in banks. A substantial portion ... sits in bank deposit products with uncompetitive yields when compared to money market mutual funds. Even for those banks that recently bumped up their deposit rates, many of these same deposit products lag anywhere from 30-40 bps on institutional accounts. In some wealth management accounts, the difference is more than a full percent."
He continues, "Money market funds have clearly proven to be resilient. It is undeniable that investors love their simplicity, convenience, transparency, professional management, and competitive rates of return. Now we recognize of course that there are currently billions of dollars sitting in bank deposits or government money funds that have once been comfortably invested in prime funds prior to money market fund reform. Yet because of specific aspects of the new rules, notably floating asset values or the potential imposition of a fear gate on redemptions, these dollars will not likely return to 2a-7 institutional prime funds. It is for these types of institutional accounts that Federated has created a prime private liquidity fund. Is it a private placement fund exclusively for qualified institutional buyers and credited investors with a $5 million investment minimum."
Ronanye adds, "In addition to all of this, investors and cash managers around the globe face many uncertainties including the Federal Reserve's many moving parts -- a new chairman, rising interest rates, balance sheet tapering -- as well as the government's debt ceiling shenanigans, numerous disasters around the globe, international concerns in North Korea, and China's recent downgrade. `I think one can make an argument that now is the appropriate time to have your cash professionally managed."
Federated Money Market CIO Deborah Cunningham comments, "Let's move now and talk about how investors are making these decisions on where to put their next investable dollar, whether it's with government, whether it's with prime, whether it's with muni, or whether it's with a bank deposit product. The answer at this point [depends] to the large degree on the spread. How much spread is enough to take into consideration ... the floating NAV and the potential for impositions of gates and fees?"
She says, "We are also seeing interest in various alternative products. Separate account mandates are ones that have been picking up of late, basically active cash, low duration strategies. These are all being explored, and basically go along with the idea of 'cash bucketing,' whereby the investor base is looking to divide their cash and liquidity needs into ... operating type cash versus strategic cash, and taking that strategic cash and placing it into securities or products that ultimately have a little bit more volatility associated with them but a substantial amount of return also in incremental value, adding incremental value to their portfolio."
On "Private funds," she explains, "We began the Federated Private Prime Liquidity Fund back in September of last year.... It is a $1.00 NAV. We use amortized cost for pricing [out to] two digits, so we round to the penny, not to the basis point. It has had no hiccups in the pricing [and it is] open to five o'clock.... It's grown steadily quarter to quarter, and is currently over $500 million.... I'm confident that we are well on our way to $1 billion at this point. The funds weighted average maturity target of 40-50 days is in line with our other 2a-7 products.... The seven-day net yield on that product is increasing, it is currently at a 1.23%, and there is an expense ratio of 15 basis points."
She was asked about money fund portals, and responds, "From a portal market standpoint, we definitely have [seen] increased use over the course of the last ten years or so by a lot of different types of investors, and the portals are important tools for those investors in the provision of information. Some of the most sought-after statistics at this point -- daily and weekly liquidity because those are the potential triggers for gates and fees, information on yields, information on weighted average maturity, information on assets sizes, etc. -- many investors gather that information through their portal usage. And in fact, they are doing that in a way where they can set their own filters. I only want to look at funds that are over X billion dollars in size. I only want to look at funds that have it least 32% or whatever it is in weekly liquidity.... I think that makes the ability for fund and flow changes to occur in a quicker fashion, and that allows potentially a little bit more competition in the market place."
Finally, Cunningham tells us, "The bank deposit market is $10 trillion or so in size. I could see a substantial portion ... starting to move slowly.... I think there is a potential for money market funds to exceed their all-time highs [$3.9 trillion] ... as long as we continue in what is a well telegraphed and slow march to slightly higher rates of the marketplace."
