Asset managers overhaul money market funds after March rout
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Some of the world’s largest asset managers are shutting down US investment vehicles that have suffered rapid outflows in times of stress, threatening an important source of short-term funding for companies across America.
Vanguard followed peers Fidelity and Northern Trust last month when it announced the closure of its “prime” money market fund. Such funds, which invest in corporate, agency and other debt with a maturity of less than one year, are seen as a more freewheeling variant of government money market funds, which invest solely in sovereign securities.
The manager’s move to convert its prime fund to one buying government bonds by the end of September will pull $125bn from the remaining $750bn invested in the prime segment. The switch comes after prime funds experienced heavy withdrawals in March, ricocheting through the funding markets they invest in and prompting the Federal Reserve to step in to restore order. Some analysts are now braced for a regulatory clampdown on the sector.
“The rewards of prime funds are no longer worth the risk,” Vanguard said.
Vanguard’s prime funds dropped by almost $4bn in March, marking the heaviest month of outflows since October 2016, as coronavirus fears spread across riskier asset classes, from equities to credit. Fidelity said its institutional prime funds fell by about a third to $12.5bn over the course of the month.
Overall, prime fund assets plummeted by $140bn to $654bn during the month, according to data from the Investment Company Institute. Meanwhile, government money market fund assets rose by over $700bn.
Heavy withdrawal requests can pose a big challenge to the managers of prime funds, who promise investors ready access to their cash — even though they are buying assets that can be hard to sell in volatile conditions.
“Typically what we see in times of stress is institutional investors rapidly moving from prime funds to government funds. We saw this again in March,” said Nancy Prior, president of Fidelity’s fixed income division. Fidelity will continue to offer prime funds to retail investors, who it said were less likely to pull their money out in times of turmoil.
Similar scenes played out in September 2008, when investors yanked $400bn from prime funds amid fears over Lehman Brothers’ solvency and corporate borrowers’ ability to repay their debts. The Reserve Primary fund, which shepherded more than $60bn at the time, “broke the buck” as the net asset value of the fund slipped below $1 a share. The episode scarred prime funds’ reputation as a safe place for investors’ cash.
In 2016 regulators introduced stringent new rules for prime funds, including the ability for fund managers to temporarily prevent investors from withdrawing their money.
But Fed economists argued in July that those rules may have actually exacerbated outflows from prime funds in this year’s sell-off, by pushing investors to try to get hold of their cash at a faster pace.
“Given the notable role of [money market funds] in the short-term funding markets and in the shadow banking system, more research and collaborative regulatory efforts are warranted to enhance the stability of the industry,” they concluded.
Joseph Abate, a managing director at Barclays, expects increased scrutiny over the size of the funds’ liquidity buffers, holdings and the eligibility of investors.
There could be more immediate effects, too, if fund closures curtail a vital source of short-dated financing for companies. The commercial paper market — where companies borrow for up to 12 months, and where prime money market funds are among the largest players — was rescued in March when the Fed set up a special purchasing programme to stave off a funding crunch. The US central bank also launched a facility that made loans to banks secured by assets from money market mutual funds, in order to ensure that they could meet demands for redemptions.
Corporate treasurers have responded to the squeeze on funding, reducing their reliance on short-dated debt by increasing the maturity of their borrowings. The total amount of commercial paper outstanding in the US has sunk from $1.13tn at the beginning of the year to less than $1tn in September — the lowest in three years.
Some analysts say that investors will continue to be drawn to the higher returns that prime funds offer, despite the risks. Pete Crane, who runs the money market fund data service Crane Data, said reports of the death of such funds are “greatly exaggerated”, adding: “Yield always wins over safety, eventually.”
But others are not so sure. If interest rates remain on hold, spreads — the additional yield available on credit over Treasuries — shrink further, and another round of regulation makes running these funds more onerous, “it is possible you could see another round of . . . closures”, said Mark Cabana, a strategist at Bank of America.