Liquidity (often described as the oxygen of the market) is an important topic for fixed-income markets, and the issue of what is and isn't liquid is often debated. The performance of money market funds (MMFs), which typically invest in short-term, highly liquid assets, have historically provided a window into market funding conditions, with periods of money market stress usually reflecting conditions across the wider capital markets. The economic and financial impacts of the COVID-19 pandemic that started to affect financial markets in the second half of first-quarter 2020 manifested into a period of extreme market volatility and liquidity stress. MMFs, typically a barometer for market liquidity, were not immune to this volatility.
In this report, S&P Global Ratings answers frequently asked questions about the evolution of MMF performance during this period of extreme volatility and illiquidity. This report also explains how MMFs help measure market liquidity overall.
Frequently Asked Questions
Who are the typical investors in MMFs and what are their key investment objectives?
As a cash management tool, MMFs are often called a safe place to park cash because their key investment objective is to preserve capital by investing in a diversified portfolio of high quality, short-dated instruments. A typical MMF will endeavor to offer its shareholders capital safeguarding (preservation) and daily access (liquidity), with a rate of return commensurate with cash-market conditions.
MMFs are offered to both institutional and retail investors. Larger institutional investors include pension funds, insurers, corporate treasurers from various sectors, local governments, sovereign wealth funds, and other financial institutions or funds. Retail investors invest in MMFs for diversification, for their higher yield compared to a bank account, and possibly for tax advantages.
What was the flow movement in first-quarter 2020?
In the first three months of 2020, US$535 billion was invested in S&P Global Ratings-rated U.S. dollar-denominated principal stability fund ratings (PSFRs), including US$514 billion in March 2020 alone. This brings the total net annual increase to US$901 billion into rated U.S. dollar-denominated PSFRs to US$3.45 trillion, an increase of 35% year on year.
U.S. MMFs ended March 2020 with more than $4.59 trillion in assets, an increase of $624 billion or 15.7% increase for the month. In March alone, U.S. institutional government MMFs increased by $364 billion (29%), U.S. institutional treasury MMFs rose by $298 billion (40%), and U.S. institutional prime MMFs decreased by $116 billion (19%) (see chart 1).
What was behind the sharply contrasting fortunes between prime and government flows?
Institutional prime MMFs generally have more exposure to bank and corporate, high-credit-quality paper than government MMFs. In March, as a flight-to-quality reaction, there was a large shift from investors moving out of prime funds and into government MMFs, which are considered the safest asset class. For example, across rated PSFRs, the average 'A-1+' credit quality at the end of March was 70% for prime funds and 95% for government/treasury MMFs.
In addition to the shift and a genuine requirement for operational cash, the sudden outflow from prime funds is also attributable to other funds with riskier strategies or assets that have invested their cash component in MMFs. When the market moves in the opposite direction, the cash in MMFs might be redeemed. It appears that up to $116 billion in outflows from prime MMFs might be due to redemptions from other funds invested in high yield, emerging markets, or equities. Cash injections to these funds, by redeeming some portion of their prime fund allocation, could stave off the need to sell their own assets at a rapidly falling price.
How stressful did liquidity conditions become in the MMF market?
In the week of March 16, right in the eye of the MMF redemption storm, prime MMFs saw $72 billion of outflows. As a result, two fund sponsors undertook actions not seen since the financial crisis, where their parent company was engaged to buy assets out of their MMFs. Notably, Bank of New York Mellon purchased assets of $2.2 billion, having seen outflows of 56% over seven days for their Dreyfus Cash Management fund. Goldman Sachs Bank USA purchased total assets of $1.8 billion out of two funds, in particular for the Goldman Sachs Financial Square Money Market Fund, whose assets fell 46% over the preceding seven days (see charts 2 and 3).
The two groups purchased assets out of the MMFs to help boost their weekly liquid assets levels, which were approaching 30%--a regulatory metric that mandates funds to hold a certain amount of short-dated assets to meet redemptions (see chart 4). If a fund was to fall below the 30% threshold, the fund's board could impose:
- A liquidity fee of up to 2% on redemptions; and
- A temporary suspension of redemptions for up to 10 days if the board (including a majority of its independent directors) determines that imposing these are in the fund's best interests.
In our view, these actions support a fund's continued operations and in our review of the fund's net asset value per share, both funds have remained in line with their rating tolerance levels (see chart 5).
When Bank of New York Mellon and Goldman Sachs Bank purchased assets from their MMFs, what were they required to do?
Any U.S.-registered MMF must file a report on a Form N-CR with the SEC if certain portfolio securities default, an affiliate provides financial support to the fund, the fund experiences a significant decline in its shadow price, or liquidity fees or redemption gates are imposed and lifted. This action by Bank of New York Mellon and Goldman Sachs Bank detailed the securities purchased and their maturities, the valuation used to price those securities, and the total amount paid for the assets.
How do recent outflows compare to the most stressed period of the global financial crisis?
In 2008, total assets for U.S. MMFs fell 5.4% to $3.4 trillion in the two weeks to Sept. 24. Net institutional fund outflows were significant, totalling $185 billion, while retail MMF assets were up by $1 billion. Notably, government MMFs, which today represent the bulk of US MMFs following the SEC's reforms in 2016, were less active back in 2008. Comparatively, in the two-week period starting March 16, 2020, U.S. MMFs increased US$423 billion, with the majority of those inflows going to institutional government and institutional treasury funds. Institutional prime MMFs have seen outflows of $67 billion, about a third of those in the two weeks of 2008, around the Lehman Brothers default.
One notable difference between 2008 and 2020 to this point is that, although they both started with a liquidity crisis, a banking crisis and a sovereign crisis ensued in the years after 2008. That said, lessons were learned following 2008 and Federal Reserve programs have been triggered more quickly this time round, quickly setting off a mechanism to help stabilize markets. It would be prudent to wait and see how the coronavirus affects the economy and markets, and the question of whether outflows will reach levels as seen in 2008 will depend on how quickly COVID-19 can be contained, the severity of the resulting economic downturn, and any lasting impact on sovereigns and issuers MMFs invest in.
Where are MMF investing inflows?
During these times of stress, fund managers are investing in very short-term, high-quality paper, treasuries, overnight repos or bank deposits, and cash. The sudden rush to U.S. government and U.S. Treasury MMFs combined with a lowering of interest rates by the Federal Reserve is creating the prospect of negative rates for government securities. This creates a conundrum for government MMFs that must invest "at least 99.5% of its total assets in cash, government securities and/or repurchase agreements that are collateralized by cash or government securities." Considering that yields might fall further with further uncertainty, MMFs must tread carefully to avoid yield dilution risk from new investors coming into the fund (see chart 6). Importantly, since March 15, 2020, and the Federal Reserve cutting interest rates, yields on overnight repo, one-month treasuries, and three-month treasuries have fallen towards zero, only one-year treasuries have remained at least 10 basis points above zero.
Subsequently, some MMFs might have to suspend subscriptions to avoid investing at negative yields. Notably, on March 31, Fidelity Investments, one of the world's largest asset managers, announced it has closed three money market funds to new investors to protect the return of existing shareholders. In a statement, Fidelity said, "Newer issues generally have lower yields than the funds' current holdings, and as such they would affect the funds' ability to continue to deliver positive net yields to shareholders."
What factors will likely affect flow movement and performance in the weeks ahead?
As long as market uncertainty continues, flows from investors will likely continue into the safest, highest credit quality assets, particularly government MMFs and already in April 2020, we have seen $141 billion invested in government and treasury MMFs. That said, flows may be impeded if MMF yields start turning negative, dislocation in the short-term debt market, pressure on sovereign debt, or a rise in downgrades of highly rated issuers. This has not happened yet. There is evidence to suggest that programs like the Money Market Mutual Fund Liquidity Facility and Commercial Paper Funding Facility have helped to promote liquidity and the functioning of MMFs. The dramatic asset declines for prime MMFs have flatlined after the announcement of these programs, and prime MMFs have seen inflows of $47 billion up to April 15.
This report does not constitute a rating action.
|Primary Credit Analyst:||Andrew Paranthoiene, London (44) 20-7176-8416;|
|Secondary Contacts:||Guyna G Johnson, New York (1) 312-233-7008;|
|Patrick Drury Byrne, Dublin (00353) 1 568 0605;|
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