Billions poured into money funds in 'dash for cash'

Ever since Mario Draghi introduced a negative deposit rate - in effect charging banks who park their surplus funds at the European Central Bank - it has been a tough time to be a money market fund manager.

Yields on money market funds, which act as reservoirs of short-term cash for banks and companies, track the ECB's record-low lending rates. But, while logic suggests return-starved investors should shun assets that offer nil, or even sub-zero, yields, MMFs now face a different conundrum: how to invest the billions flowing their way.

Last week saw a record $23.46bn flow into European MMFs in spite of fears rock-bottom ECB rates would make it harder for them to make money, according to EPFR, the data provider.

Why? The eurozone's worsening economic outlook - reflected in steep European equity market falls and rising borrowing costs for "peripheral" eurozone governments, have triggered a "dash for cash". Wednesday's market turmoil, while dramatic, is part of a wider shift, well underway, out of riskier assets into havens.

"It reflects risk aversion among investors and lack of alternatives," says Charlotte Quiniou, a director at Fitch, the ratings agency.

"We saw large inflows during the summer and in September at the same time as very low yields are being offered in the eurozone and low or even negative bank deposit rates. In that context those MMFs which are still able to deliver a marginal positive yield are an attractive solution."

By contrast, back in March, when growth prospects appeared rosier, it was revealed that MMFs had shed nearly a fifth of their assets under management to €926bn over the previous three years.

Since then, key MMF rates such as the Euro Overnight Index Average, dubbed eonia, which tracks overnight lending rates, have plunged into negative territory, presently yielding minus 0.018 per cent. Longer rates - such as euribor 1 month and 3 month rates - are mired in single digit basis points.

Now there are worries that banks, following the ECB's example, could charge companies to guard their surplus cash.

"There are concerns about the possibility that custodian banks may start to apply negative rates to deposits," says Yaron Ernst, a managing director at Moody's.

Those funds restricted to only buying short-duration assets such as 'constant net asset value' funds - which account for about a fifth of the euro denominated MMF market - have been hit hardest. They are 'constant' because they offer investors the implicit guarantee that they can take €1 out for every €1 they put in.

"We are already in an environment where some CNAV funds are providing zero or extremely low returns to their shareholders," says Thierry Darmon, global head of treasury management at Amundi, which runs one of the biggest euro MMFs by value.

That has prompted some managers to lengthen the average maturity of the assets in which they invest. Amundi, for example, lengthened the average maturity of one CNAV fund from one day to forty days. Overall, the average maturity for euro-denominated MMF assets has increased from 51 days in April to around 58 days since May. Others have had to consider closing their funds to new money which would erase returns to existing investors.

"Several MMF managers have said that in case of large inflows, they would likely limit subscriptions to their funds, because new inflows invested at lower yields would dilute the returns for existing fund investors," says Mr Ernst. "Some institutional investors may start looking for alternative liquidity solutions, such as separately managed accounts or ultra short-term bond funds".

'Variable net asset value' funds, whose value fluctuates along with the market, are permitted to invest in assets with a maturity up to one year. Seeking to boost meagre returns, many managers have implemented a so-called 'barbell' strategy where they invest in more longer-dated assets, which offer better yields, while offsetting the risk of rising interest rates with investments in assets with very short-term maturities.

The bigger question is what would happen if money market fund returns go negative. "It has not been tested how investors will react to negative yields - [but] we think it will be tested at some stage given where rates are going," says Ms Quiniou. "They may go into products which are more risky."

New regulations could make it yet harder to maintain yields. EU authorities have proposed that some MMFs should hold capital buffers equal to 3 per cent of their investments, which could force returns down further. Regulators say they want to make money market funds safer and avoid a run on the market in the event of another financial crisis. Critics contend it could put some funds, especially CNAVs, out of business.

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