Another challenge facing money fund portfolio managers was an increased focus on current yield. The changing face of distribution models, including the growth of financial intermediary portals and the daily transparency provided by fund families and data providers, has increased the competitive landscape for money funds. Savvy institutional investors pay very close attention to 1-day and 7-day yields and can efficiently make changes to their allocations between funds and fund families with a click of the button. This makes money fund managers sensitive to preventing drops in current yield. In a declining rate environment, when facing an inverted yield curve, there is less incentive to term out assets because it immediately depresses the current yield. This short-sighted view may benefit current yield today while missing potential upside down the road. Money fund portfolio managers have to balance both worlds.
Regulatory changes that went into effect following the Global Financial Crisis also played a role in why funds were so short. The implementation of potential fees and gates tied to a fund’s weekly liquid assets changed how Prime money fund portfolio managers construct portfolios. To avoid any risk of flirting with minimum requirements, Prime money funds target weekly liquid asset levels around 40%. This biases portfolio WAMs lower. In order to extend WAM, more assets have to be invested in longer maturities for a barbell strategy. The timing of establishing the fund’s barbell is always very important. The risk remains if trade policy progress was made while the domestic economy continued to grow, the Fed could pause. There’s a risk a fund could get long while the market was pricing in cuts, only for the Fed to stop easing. This has the potential to depress portfolio yields over an even longer time frame. Instead, if a fund hedged with a more laddered approach to new purchases, the fund is protected against the Fed changing tune, but at the cost of a lower WAM. Government money funds were also affected by the post-Global Financial Crisis regulatory reforms but in a very different way. The asset migration out of Prime money funds left the bulk of money market cash in Government strategies. Trying to change portfolio strategy in very large funds can be challenging and at the mercy of issuer supply. In a market that prices in
changes to rate expectations almost instantaneously, scale can hinder how nimble a portfolio is and how quickly it can change strategy.
Last, but certainly not least, was money market assets under management (AUM) grew massively throughout the year, both in Prime and Government strategies. Institutional Government money funds’ AUM, year-to-date through October 31, 2019, increased by $181 billion.6 Prime Institutional money funds’ AUM rose by $244 billion over the same timeframe.7 The drivers of the cash inflows varied between corporate deal flow, fixed income investors shortening duration due to the inverted yield curve and risk aversion to equities at all-time highs among others. Cash inflows in a declining rate environment are a bit of a winner’s curse as new assets drag down duration metrics, increase liquidity and lower portfolio-level yields. Even as the new cash pushed yields lower, investors continued to invest in the funds. Determining how long new assets will stay invested in money funds is very important to the positioning of said funds. Trusting that the cash is “sticky” allows you to invest out the curve and take advantage of term premiums if and when they exist. In the absence of that confidence, or if the stated timeline of the investment is short-term, investors are biased to keeping liquidity on hand.