One week ago, we hosted our "Money Fund Symposium Online," which featured an afternoon of presentations and discussions on money market mutual funds. Last Thursday, we quoted from the keynote speech (see our Oct. 29 News, "ICI's Stevens Keynotes Crane Event, Says Money Funds Didn't Drive Crisis"), and yesterday we quoted from the closing panel (see "More Symposium Highlights: Callahan, Cunningham on Future of MMFs"). Today, we excerpt from our "Ratings Focus: Governance, Global & LGIPs," segment, which featured brief presentations from S&P Global Ratings' Michael Masih, Moody's Investors Service's Rory Callagy and Fitch Ratings' Greg Fayvilevich. (For those that missed it, the MFS Online recording is available here. Our next webinar, European Money Fund Symposium Online, is Nov. 19 from 10am-12pmET.)
Moody's Callagy comments, "Before I get to our thoughts on credit quality within money funds and thoughts on ESG, I just want to do a lay of the land in terms of our outlook for the money fund industry. On the 18th of March, we changed our outlook for the industry to negative from stable. With the onset of the coronavirus we saw significant dislocation in the short term credit markets, which resulted in a stress on funds' NAVs and funds' liquidity. And while we didn't take any rating actions on funds in the U.S. or Europe as a result, the Fed and other central banks stepped in and governments, to provide unprecedented support that helped normalize markets."
He explains, "Our view was the industry overall would be challenged and that there would continue to be stress in the market. So we maintain a negative outlook. Looking ahead to 2021, I think some of the challenges that the industry faces [include] we expect more fee waivers, which will weigh on the profitability of money market fund sponsors. The spread between prime and government funds has narrowed, which makes the Prime segment less attractive to investors."
Callaghy adds, "And lastly, this was touched upon in the last segment, but our expectation is that we'll see more regulation in the money fund space. It may not be next year, but in the coming years as a result of some of the performance issues that we experienced earlier this year. And that's likely to cause additional players to exit the market, so that will lead to a more consolidated industry as ... some may make the decision that the investment to comply with the new regulations is not worth the return. We think that the industry as a result, becomes even more concentrated than it already is, which reaffirms our view that there are still some negative headwinds that the industry will face next year."
S&P's Misah tells us, "Some of the key metrics that I'll highlight today are tier one credit quality, portfolio composition, maturity distributions, net asset movements and obviously yields as well. We'll start off with yields. Obviously, it's been a key theme and topic in the industry over the last couple of months. In the most recent quarter, with the lower rates impacting yields from money market funds, we really saw higher yielding paper prior to the Fed's actions in March sort of starting to mature off, which has started to show yield compression amongst the money market funds. So about 3 basis points for government funds and 13 basis points for prime funds, respectively. It's very similar for the 7-day yield and 30-day yield. But, based on where the Fed direction and guidance is, we're going to stay in a lower rate environment for the long term."
He continues, "With regards to AUM and flows, at the end of the third quarter U.S. money market fund assets, in terms of the rated side, stood at $3.1 trillion. We saw rated government funds see outflows of 6.3% to stand at approximately $2.6 trillion. We think that the main driver for this slowdown was obviously the compressed yields, but also some investors decide to shift outside of money market funds to seek additional high yielding or better yielding liquidity products such as ultra-short funds and possibly SMAs, or separately managed accounts. Despite the ongoing concern with the pandemic and potential for additional volatility, prime fund assets actually remained fairly consistent at around $500 billion over the last quarter."
Misah also says about portfolio composition, "For both prime funds and government funds, we continue to see higher quality assets in general. As of September, government funds held about 57% in direct treasury exposure versus 38% this time last year, and then the remainder of allocations to repo and agencies. For prime funds, we saw about 10% holdings in direct treasuries versus 3% this time last year ... then the remainder of prime funds are invested in overnight time deposits, repo and corporate CP. We actually saw a little bit of an uptick on corporate CP allocations, to about 25% versus about 20% the last quarter.... An overwhelming majority of rated funds' mark-to-market NAVs, ranged within a narrow band of 0.9995 to 1.0005. So, you certainly see more stabilization there."
Callagy also comments, "Michael touched on the fact that prime funds are managing more cautiously, and as a result they're holding more sovereign assets, Treasury assets, which improves the credit quality of the funds overall. When we think about credit quality within prime funds, we're really looking through to the banking sector and the credit worthiness of banks globally. When we started the year, Moody's had 14% of its banking systems on a negative outlook, now, that's 76%. So, with the onset of the coronavirus and the crisis that we're currently living in, that's had a significant impact on operating conditions for banks."
He continues, "Moving into ESG, this is an area that, just stepping outside of money market funds, we think is going to be where the next big secular growth area is for the asset management industry. Investors globally are more focused on this and demanding that the asset managers that they allocate to are taking ESG seriously and implementing it, incorporating it into its investment processes. We've seen a couple of dedicated ESG funds launch in the U.S. and Europe. I don't think we see a flurry of dedicated ESG products coming behind that. I think what you will more likely see is that asset managers will be incorporating ESG considerations into their investment process, which will feed into the investment strategies that they put into the market."
Callaghy adds, "In terms of money market funds, prime money market funds, they invest mostly in banks. The factors I think are most relevant would be governance, and we've seen some recent governance issues in the banking space, as well as social considerations. So those are some of the main points. But I think, for the ESG market to take off even further in the US, I think you have to see more standardization. There's a lack of standardization in the markets. There is also this perception that you have to give up some return in order to do good. I think we think that that's somewhat of a misperception, and that will be proven out over time as more money is allocated to these types of strategies. But expect more to come in the ESG space for money market funds."
Finally, Fitch's Fayvilevich comments on LGIPs, or local government investment pools, "We divide LGIPs into two main categories. What we call the liquidity LGIPs, those really look very similar to money market funds, most often prime money market funds, they will invest in credit, they'll adhere to pretty much all of the 2a-7 requirements, including the 60-day WAM, etc. The differences and maybe the advantages of LGIPs are that they are not regulated by the SEC, and they can kind of set their own rules. There are some ground rules that ... the Accounting Standards Board sets for them. `The two main advantages are, one, they can continue operating at a stable NAV, so even for prime style funds no floating NAV requirement, as well as no fees and gates. So, around money market reform time, and since then, we've seen some migration of public sector entities who could invest in these types products move away from prime funds into LGIPs."
He continues, "The second type of LGIPs that we classify are what we call short term LGIPs, so they look much more like short term bond funds. Not so much ultra-short, but really short term with durations in a one to two-year area, and max maturity is going out three to five years. They buy a lot of government securities, long-dated treasuries, agencies, often ABS as well, and investment credit. These two types of LGIPs, they can range all over the place in terms of how they're managed. They can be externally managed by similar fund managers who manage money market funds, or they can be internally managed by the county Treasury Department, state level, or you have city level LGIPs. Each will cater to different types of investors. There are also rated and non-rated LGIPs, so the dashboard reflects a mix of all these."
Fayvilevich adds, "The trend ... in terms of assets is significant growth in this space. The LGIPs we track are now up to a record, at least in terms of our data set, of about ... $350 billion dollars in AUM, and actually grew by just over $50 billion year-over-year. We've seen more of the growth in the liquidity style LGIPs than the short term bond funds.... The assets have an element of seasonality.... You'll see that in the second quarter and in the fourth quarter especially, there's a lot of money coming in and that really has to do with the tax collection season.... Money going out, this is also fairly predictable and generally on payroll, debt service or proceeds from debt issuance and things like that, and certain projects that have defined timeframes. The advantage these type of vehicles have is that the cash flows are much more predictable."
