Wells Fargo Asset Management's most recent monthly Portfolio Manager Commentary" discusses the most recent round of money market fund reforms and how funds might hold up during a recession. They tell us, "While not all recessions are created equal, the most recent SEC rules implemented in 2016, acting in combination with the stringent regulations imposed on the banking sector after the financial crisis, have created an even more stable backdrop for MMFs than existed in the past. The new rules that came with the SEC's MMF revamp, discussed in greater detail below, are consistent with the conservative manner in which our funds have always been managed, emphasizing preservation of capital and high levels of liquidity."
The update continues, "Although the SEC has required prime funds to maintain minimum positions of daily and weekly liquid assets of 10% and 30%, respectively, since 2010, the 2016 reforms to SEC Rule 2a-7, which governs MMFs, went a few steps further by coupling those limits with liquidity fees and gates in the event of their breach. Those few additional steps prompted investor concern over the potential loss of liquidity from the imposition of fees and gates. To recap, the rules give fund boards the ability to impose a liquidity fee or redemption gate if a fund's weekly liquidity level drops below 30%. Probably in large part to avoid triggering such an event, fund managers have typically maintained weekly liquid asset levels well above the 30% threshold."
It explains, "In addition to adhering to regulatory requirements, we believe the most important aspect of liquidity management is understanding the liquidity needs of the different investors in the fund. We have long-established know-your-customer procedures that allow for ongoing and regular communication between the sales and investment teams. As a result, the portfolio management team is better able to understand the nature and timing of the fund's cash flows and manage the fund's liquidity accordingly."
Wells also says, "The adoption of a floating net asset value (NAV) was also a significant concern for investors who were uncertain how much fluctuation they would see in their daily principal balance. We now have nearly three years of empirical evidence that shows institutional prime MMF NAV fluctuations have been minimal. The weekly liquid assets profile of a fund, as well as its holdings in floating-rate paper, can help decrease the NAV volatility that comes from the changing values of fixed-rate securities as interest rates change."
They write, "In addition to adopting the 2016 changes imposing the floating NAV and the possibility of fees and gates, MMFs continue to be required to meet Rule 2a-7's guidelines surrounding credit diversification, maturity restrictions, and risk oversight, all of which shape a product that should better withstand exogenous events, including a recession. The rule's credit diversification requirements allow funds to invest in a wide range of credits but limit the exposure to any single issuer. The intent of this rule is to minimize the impact of any single credit on a well-diversified portfolio. In addition, we have a dedicated credit team that reviews each issuer to help ensure minimal credit risk is maintained."
The authors explain, "Rule 2a-7's maturity restrictions serve to minimize the NAV impact of interest rate changes as shorter securities, those maturing sooner, have smaller price variations from a given interest rate move than longer securities, helping ensure a more stable product. Finally, our risk management team's stress tests of a MMF's ability to withstand certain hypothetical market stress events are an important tool used by portfolio managers. These hypothetical events include increases and decreases in short-term interest rates, downgrades or default of portfolio security positions, and a correlated increase in the credit spreads for certain portfolio securities, in combination with increases in shareholder redemptions."
They continue, "Having had an extended period to observe weekly liquidity levels in prime MMFs, investors appear to have become more comfortable with the ideas of a floating NAV and of fees and gates. Taken together, the demonstrated ample liquidity and relatively stable fund NAVs have encouraged investors to begin to move back into prime funds with at least a portion of their money market cash. As shown in the chart on the next page, prime assets have increased 87% since the 2016 SEC reforms and 26% since the beginning of 2019."
Finally, Wells writes, "Aside from Rule 2a-7, the capital requirements imposed on the banking sector by Dodd-Frank and the increased amount of high-quality liquid assets banks are required to hold, in part to meet highly adverse stress test scenarios, are in place to minimize the impact of a recession or an unexpected event on banks and systemically important financial institutions.... [T]he more robust banking regulations are especially beneficial to prime MMFs as they enhance the credit profile of a large portion of the funds' underlying assets.... Over the prime MMF complex, holdings of a variety of security types issued by the finance sector represent 58% of fund assets. Additionally, repurchase agreements secured by government securities executed with bank counterparties, as well as direct investments in government securities, comprise another 28% of prime funds' holdings."
The commentary concludes, "The liquidity, maturity, and diversification requirements mandated by the SEC have led to a more stable MMF product, especially in terms of liquidity and minimal NAV fluctuations, with an improved resilience in the face of market stresses. In addition, the bulk of the underlying holdings of the prime MMF sector are in securities issued by financial institutions, which have themselves been made more resilient by post-crisis regulations. If the economy does in fact slip into recession, the various changes to MMF and banking regulations have made MMFs better positioned to withstand economic stresses."
In other news, money fund assets rose again this week, the 19th increase out of the past 21 weeks. ICI's latest "Money Market Fund Assets" report shows that assets have increased by $350 billion, or 11.5%, year-to-date. Over the past 52 weeks, ICI's money fund asset series has increased by $516 billion, or 17.9%, with Retail MMFs rising by $234 billion (22.0%) and Inst MMFs rising by $283 billion (15.5%).
ICI writes, "Total money market fund assets increased by $16.77 billion to $3.40 trillion for the week ended Wednesday, September 11, the Investment Company Institute reported.... Among taxable money market funds, government funds increased by $10.25 billion and prime funds increased by $7.01 billion. Tax-exempt money market funds decreased by $490 million." ICI's weekly series shows Institutional MMFs rising $11.6 billion and Retail MMFs increasing $5.2 billion. Total Government MMF assets, including Treasury funds, were a record $2.534 trillion (74.6% of all money funds), while Total Prime MMFs were $729.21 billion (21.5%). Tax Exempt MMFs totaled $134.4 billion, or 4.0%.
They explain, "Assets of retail money market funds increased by $5.17 billion to $1.29 trillion. Among retail funds, government money market fund assets increased by $2.74 billion to $739.73 billion, prime money market fund assets increased by $2.78 billion to $430.05 billion, and tax-exempt fund assets decreased by $351 million to $124.37 billion." Retail assets account for over a third of total assets, or 38.1%, and Government Retail assets make up 57.2% of all Retail MMFs.
The release adds, "Assets of institutional money market funds increased by $11.60 billion to $2.10 trillion. Among institutional funds, government money market fund assets increased by $7.51 billion to $1.79 trillion, prime money market fund assets increased by $4.23 billion to $299.16 billion, and tax-exempt fund assets decreased by $139 million to $10.08 billion." Institutional assets accounted for 61.9% of all MMF assets, with Government Institutional assets making up 85.3% of all Institutional MMF totals.
