Investors leaving money market safe havens

As market volatility has eased, institutional investors are moving away from the safety of U.S. money market funds and moving back to more return-seeking investments.

Data from Morningstar Inc. show that investors are taking initial steps away from money market funds, with assets in U.S.-domiciled funds dropping to $4.6 trillion at end of June from $4.75 trillion at the end of May.

The trend is nascent. Money market balances remain higher than they were before the coronavirus pandemic took hold in the U.S. in mid-March. But industry sources said the decline shows that asset owners are growing more comfortable with risk. Meanwhile, money managers are waiving fees on their money market funds to maintain investors' yields above zero.

The largest institutional money market funds in the U.S. are offering a seven-day yield in the 0.24% to 0.35% range, according to data provider Crane Data LLC.

Assets invested in the U.S. money market funds were 6.9% higher at the end of June than as of March 31. Institutional investors had been parking cash in money market funds at the height of the pandemic in March and April. They were banking on these funds for their liquid nature combined with a safe-haven status.

Sources said now some investors could be concerned about the possibility of negative rates in the U.S. and in the U.K. later this year with some investors rotating into higher-yielding fixed-income investments.

Matthew Maleri, partner at Rocaton Investment Advisors LLC in Norwalk, Conn., said that in part the Federal Reserve's monetary policy response to the COVID-19 crisis could result in encouraging investors to move out on the risk curve. "With short-term interest rates expected to stay near zero for several years, further outflows from money market funds would not be unexpected," Mr. Maleri said.

Investors said they are watching whether negative rates on money market funds could emerge later this year and whether any shift in rates would alter their cash management preferences.

Interest rate cuts by the Fed have reduced the yield on short-duration assets, said Steve Esack, spokesman for the $59.1 billion Pennsylvania Public School Employees' Retirement System, Harrisburg.

"There currently is no support for negative interest rates on the Fed's Board of Governors," Mr. Esack said. "Still, the potential for negative interest rates is an issue that we are monitoring closely."

The pension fund has increased its exposure to Treasury bills as spreads on other strategies have been tightening significantly given the unprecedented accommodations by the Fed. Mr. Esack declined to specify the increase but said it was funded from the sale of money market funds. The pension fund's strategic allocation to cash is 6%.

Tapan Datta, global head of asset allocation at Aon PLC in London, noted that some investors are rotating back to equities from cash because holding safe-haven assets could mean negative returns or losses if inflation picks up.

"There is a big debate whether negative rates could be accepted in the U.S. The Fed would not move into the negative territory unless it has to. But markets are expecting there is a probability it could happen," Mr. Datta said.

Meanwhile, money market fund managers are trying to keep investors in their cash strategies.

Dennis Gepp, managing director and CIO of cash at Federated Hermes Inc. in London said: "I have to admit I was surprised — given where we stand with COVID — and the relatively long-term period of uncertainty … how quickly a number of markets saw cash flow back to them," after investors had allocated into cash and away from long-term debt, equities and emerging markets earlier in the crisis. Mr. Gepp added that cash managers in the U.S., including Federated, began to apply fee waivers to clients much like they did during the global financial crisis. Federated applied waivers for the month ended June 30, according to a July 29 notice.

During the credit crunch in 2008, Federated waived $600 million of fees so investors could earn a positive return. "We know already that 50% of share classes of (U.S. industry) money market funds are having to apply fee waivers," Mr. Gepp said. Although the returns on money market funds are still positive, if you try to take a full fee, it would mean investors earn a negative return, he said. Federated managed $457 billion in money market fund assets as of June 30, increasing by 1.3% since March 31.

By comparison, assets in Europe-domiciled money market funds have increased to $1.4 trillion as of June 30 from $1.3 trillion as of March 31 despite negative rates.

Jemma Clee, executive director and lead international investment specialist, global liquidity at J.P. Morgan Asset Management in London, said negative rates on money market funds introduced in Europe six years ago could be a "script for sterling." Ms. Clee said her firm would consider fee waivers for sterling if the rates in the U.K. turned negative. The European Money Market Fund Regulations in 2019 changed and instituted a framework that accounts for negative rates on money market funds, Ms. Clee added.

If sterling interest rates were to move lower, causing net yields on sterling money market funds to dip negative, Ms. Clee said the firm could utilize the approach from the euro funds to accommodate negative yields. On July 20, the Bank of England signaled to the market it has policy room available to lower rates depending on market conditions, she said. "They are keeping that possibility (open)," she said.