This conversation will review money markets during the COVID-19 crisis, subsequent policy responses, and how money market funds remained a resilient cash choice for investors.
Laurie King: I’m Laurie King and you are listening to On the Trading Desk®. Today we’ll be talking about money market funds. These are a specific type of mutual fund that both retail and institutional investors may use as a way to invest their short-term cash. So we’ll be discussing how the COVID-19 liquidity crisis affected them and how we see them going forward. To discuss, our guest today is Jeff Weaver, Head of Money Funds and Short Duration Strategies at Wells Fargo Asset Management. Welcome to the program, Jeff.
Jeff Weaver: Thank you, Laurie. Happy to be here.
Laurie: So Jeff, you manage cash portfolios and money market funds here at WFAM. We have all heard that “cash is king” and that was certainly evident during the COVID-19 liquidity crisis. Can you give our listeners an overview of what happened in the money market fund space during March?
Jeff: Yes, absolutely. And what a month March was. U.S. equity markets peaked in mid-February and began a serious decline in the last week of February and into March as fears of COVID-19 gripped the market and folks were asked to work from home and certainly a lot of concerns about job losses and the economy. And as a result, there was a tremendous flight to quality in liquidity as investors sold risky assets and flooded the market in pursuit of cash positions. In early March, the FOMC decreased interest rates on March 3 by 50 basis points and again on Sunday, March 15 by an additional 100 basis points to ultimately reduce the Fed funds target range to 0% to .25%. And this is with the goal of creating an accommodative monetary policy to help ease the burden of funding throughout the COVID crisis. At the same time, there was a tremendous amount of cash that made their way towards money market funds. In the month of March alone, $790 billion flowed into government and treasury money market funds. At the same time, $160 billion came out of prime money market funds as they were perceived to be more risky.
Laurie: And from your vantage point, you’ve also had a front-row seat to see to Federal Reserve policy responses being implemented.
Jeff: Yes, that’s right, Laurie. That has certainly come with a number of programs and we’ve written about them on our blog and our portfolio manager commentary from the money market fund team. Before I highlight the one program that was really crucial for money market funds, and that being the Money Market Liquidity Facility or MMLF, I thought it’s important that I should set the stage and provide some background for prime money market funds in particular.
SEC Rule 2a-7 requires that money market mutual funds maintain 10% in daily liquidity and 30% in weekly liquidity. So fund managers typically maintain liquidity but beyond these requirements with most funds having been about 40% in weekly liquidity or more. And what we saw in the month of March is as prime redemptions grew, fund managers were being forced to sell longer assets in order to maintain these liquidity requirements. Unfortunately, these sellers were met with a tremendously illiquid bond market and bid on these high quality, typically very liquid securities were at best highly distressed or in many cases, nonexistent. So, as prime fund redemptions accelerated, the Fed smartly instituted the MMLF on Wednesday, March 18 at Midnight Eastern Time in order to provide liquidity to prime and to a lesser extent, municipal money market funds, and to begin to repair the dysfunctional short-term credit markets.
Whereas some of the Fed’s programs’ effectiveness were questionable, the MMLF certainly hit the mark. MMLF-eligible assets include domestic commercial paper, asset-backed commercial paper, certificates of deposit, and municipal securities, including VRDNs. Also eligible were floating rate structures and Yankee CDs, which are CDs issued by U.S. branches of foreign banks. These are all assets that are widely held by prime funds. The facility allowed for prime and municipal money market funds to sell these eligible securities to broker-dealers at amortized cost while those broker-dealers were able to have those purchases financed by the Fed at a rate of prime +100 basis points, or 1.25%.
Once the facility was in place, prime funds were able to get the liquidity necessary to meet redemptions. Redemptions began to slow, and by the end of March and into April, those redemptions reversed and turned into additions as short-term markets began to repair and investors started to see value in prime money market fund yields.
Laurie: So now that we’re in the middle of April, how do you feel the short-term bond markets are working now?
Jeff: Short-term bond markets are much better, but they have yet to completely normalize and be in a position to provide good two-way liquidity for market participants.
In the money market space, we look at the yield spread between LIBOR and the Overnight Indexed Swap rate, or LIBOR-OIS. LIBOR-OIS can be used as a measure of stress in the market. On February 20, LIBOR-OIS was at 12 basis points. By March 31, that had widened to 138 basis points, levels not seen since the 2008 global credit crisis. Today, LIBOR-OIS is back down to 103 basis points.
Similarly, we can look at 1-to-3 year investment grade corporate bond spreads, those bonds that are beyond the money market universe, but another indication of risk. On February 17, 1-to-3 year investment grade corporate bond spreads had a yield spread of 46 basis points. On March 23, that spread widened to 443 basis points, again a level not seen since the global credit crisis. Today, we’re back at 206 basis points.
So by using these as an indication of the health of the market, we believe the worst is certainly behind us and that the retracement of yield spreads are indicative of an improving market.
Laurie: So the market’s beginning to improve, but still, investors have expressed some concerns about money market funds. What do you tell them about how prime money market funds performed during the crisis?
Jeff: We’ve had to spend a lot of time over the past month reminding and educating investors about the money fund reforms that went into place on October of 2016.
At that time, prime and municipal money market funds were split into those exclusively for retail investors and those for institutional investors. The reason these two investors were split was because institutional investor flows were not only larger, but typically much more volatile, particularly in times of stress.
After reform, retail prime funds, limited to natural persons only, would continue to have a constant NAV of $1, just like government and treasury funds. However, going forward from that time on, institutional funds would have a floating NAV. That floating NAV goes out to 4 decimals, so 1.0000 as a starting point. Floating NAVs would change daily as market prices change. They can drift above $1 as prices increase and they can drift below $1 as prices decrease.
Additionally, for both retail and institutional funds, if the 30% weekly liquidity minimum mentioned earlier was breached, a funds board would have the choice whether or not to put in place a redemption gate, which would disallow withdrawals for up to 10 days, or liquidity fees, which would allow the fund to charge up to 2% for any withdrawals. Therefore, it became very important for fund managers to maintain a minimum of 30% liquidity.
Post-reform, institutional investors became accustomed to a floating NAV. The fourth digit, which represents a basis point, would move up or down by one or two notches every so often. In general, floating NAVs increased post-reform, and as rates moved lower in the beginning of this year, many of the NAVs increased by 4 or 5 basis points as interest rates continued to come down.
In March, as market worries about COVID-19 increased and bond market illiquidity increased, institutional prime investors began redeeming their shares. These forces combined to cause floating NAVs on institutional prime funds to fall. Most NAVs across the industry fell 15 to 20 basis points or more over that period of time from a slight premium to 1 to a slight discount.
So as an example, it’s possible that a floating NAV on an institutional prime fund would’ve dropped from 1.0008 to .9991, a 17 basis point drop. Many confused this drop below 1 as “breaking the buck”, which is a term that should be reserved for constant NAV funds. Breaking the buck occurs in a constant NAV when the shadow, or market, NAV drops to .9949 or a 51 basis point decrease from 1.
Since the MMLF was put in place and as redemptions turned to additions, most floating NAVs have increased off of their lows and are, in fact, moving back towards levels seen towards the end of last year. With the stabilization in NAVs, many investors are being attracted to the yield advantage of a prime fund versus a government fund.
I think it’s important to note, as anticipated by our forum, it was the institutional investors that dominated outflows while retail funds were much more stable through this last period.
Laurie: So government money market funds benefited from the crisis, meaning they had significant inflows. What can you tell our investors about them?
Jeff: Yes, Laurie. During these volatile times, investors typically increase their cash position, and much of those cash positions find their way to the safety and liquidity of government and treasury money market funds.
At Wells Fargo Asset Management, we have three government funds. The Wells Fargo Government Fund, which invests in treasuries, agencies, and repos secured by treasures and agencies. We have the Treasury Plus Fund, which invests in treasury securities and repos secured by treasuries. And then we have the 100% Treasury Fund, which solely invests in treasuries.
With the Fed funds rate now at a target range of 0 to 25 basis points and the Fed expected to remain accommodated for some time, we’ve seen yields on these funds gravitate toward zero basis points. I think it’s important to note that as fund yields trend toward zero, mutual funds begin to waive fees in order to maintain a yield of zero or 1 basis point.
Another thing that’s come up in this environment is the fear of or the concern for negative interest rates. We do not believe that the Fed will employ a negative interest rate policy, but nonetheless, that does not keep treasury bills from trading negative when demand outstrips supply.
Fortunately for government and treasury funds, with all the federal programs being put in place, the treasury is going to be increasing treasury supply by about $3 trillion, and about $1 trillion of that supply will be in treasury bills. So much of the pressure driving bill yields negative is now being relieved. And over the last two or three weeks, the increase in issuance of bills has moved bill yields from negative to positive.
Laurie: So what do you want investors to know about money market funds after the volatility in March?
Jeff: During the month of March, we saw tremendous outflows from long-term muni bond funds, many of which invest their cash in VRDNs or municipal money market funds that invest predominantly in VRDNs.
About $10 billion in outflows were witnessed from muni money market funds. Those are predominantly in VRDNs it ended up on dealer balance sheets. In order for dealers to clear those from their balance sheets, they need to increase yields in order to make them attractive for investors.
SIFMA, which is the weekly rate that’s indicative of variable-rate demand note yields, rose from 1.28% on March 11 to 5.2% on March 18. This provided an excellent opportunity for investors with excess liquidity. Because we increased our liquidity by so much in our prime funds from 40% to over 60%, we had a tremendous amount of cash that can be invested in a variety of securities. One of the places that we found opportunity was in VRDNs. Many of these VRDNs were trading as high as 7% or 10% during that week.
I think what’s important to note is during this whole time, VRDNs traded at par. It was just the rate that had changed, making them more attractive to investors, such as ourselves.
Laurie: So as a final question for you, what’s on the mind of the types of money market clients we work with these days? What are the conversations that you’re having with them now, amid the uncertainty of today’s economy?
Jeff: Many clients are now becoming much less fearful as we get more and more information on COVID-19, as we witness a flattening of the curve, and as we begin to contemplate moving beyond the current shelter-in-place environment.
We continue to see inflows into government money market funds, but we are also receiving increased inquiries and opportunities in prime and municipal money market funds, in addition to longer strategies in order to gain additional yield.
Many conversations have changed to concerns about credit quality in short-term credit markets and concerns about downgrades by rating agencies as we enter into the slowdown in the economy. Nonetheless, our analysts and portfolio managers continue to be vigilant in purchasing high-quality assets across our money market complex and the objectives of providing liquidity and preserving capital continues to be at the top of our priorities.
Laurie: Well, Jeff, thank you very much for your insights today, helping us understand what’s happening in the money market space.
Jeff: Thank you very much, Laurie.
Laurie: For our listeners, if you’d like to learn more about short-term markets and money market funds, go to wellsfargoassetmanagement.com to read more. In fact, you’ll find a number of our rapid response commentaries about money funds and the illiquidity crisis right there on the website now. Until next time, I’m Laurie King; take care.
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For floating NAV money market funds: You could lose money by investing in the fund. Because the share price of the fund will fluctuate, when you sell your shares they may be worth more or less than what you originally paid for them. The fund may impose a fee upon sale of your shares or may temporarily suspend your ability to sell shares if the fund’s liquidity falls below required minimums because of market conditions or other factors. An investment in the fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. The fund’s sponsor has no legal obligation to provide financial support to the fund, and you should not expect that the sponsor will provide financial support to the fund at any time.
For retail money market funds: You could lose money by investing in the fund. Although the fund seeks to preserve the value of your investment at $1.00 per share, it cannot guarantee it will do so. The fund may impose a fee upon sale of your shares or may temporarily suspend your ability to sell shares if the fund’s liquidity falls below required minimums because of market conditions or other factors. An investment in the fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. The fund’s sponsor has no legal obligation to provide financial support to the fund, and you should not expect that the sponsor will provide financial support to the fund at any time.
For government money market funds: You could lose money by investing in the fund. Although the fund seeks to preserve the value of your investment at $1.00 per share, it cannot guarantee it will do so. An investment in the fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. The fund’s sponsor has no legal obligation to provide financial support to the fund, and you should not expect that the sponsor will provide financial support to the fund at any time. For the municipal money market funds, a portion of the fund’s income may be subject to federal, state, and/or local income taxes or the alternative minimum tax. Any capital gains distributions may be taxable. For the government money market funds, the U.S. government guarantee applies to certain underlying securities and not to shares of the fund.
Carefully consider a fund’s investment objectives, risks, charges, and expenses before investing. For a current prospectus and, if available, a summary prospectus, containing this and other information, visit wfam.com. Read it carefully before investing.