Since the US credit crisis, both SEC changes implemented in 2010 and ongoing investor risk aversion have driven US prime money market funds (MMFs) to significantly increase their portfolio liquidity, according to a Fitch Ratings study.
As of end-September 2012, liquid assets represented approximately 45 per cent of MMF assets, compared to approximately 20 per cent of total assets at end-2006.
Fitch’s study identifies three distinct phases when MMFs increased liquidity: (1) during the US financial crisis, particularly after the August 2007 stresses affecting structured investment vehicles and the asset-backed commercial paper market; (2) after the announcement and implementation of the 2010 Rule 2a-7 amendments; and (3) during mid-2011 as Eurozone market volatility started to escalate.
“US financial regulators, including the FSOC, remain focused on the ability of money funds to weather market distress, and strong liquidity is important to meeting redemption requests and providing confidence during volatile periods,” says Roger Merritt, managing director and head of Fitch’s fund and asset manager ratings group.
While the 2010 SEC rule changes essentially place a floor on fund liquidity levels, it is unlikely that currently high MMF allocations to liquid assets will persist, particularly if Eurozone stresses were to ease and the supply of high quality assets were to decline further.
“Since maintaining high liquidity dampens returns, an easing in market volatility could motivate funds to reduce these buffers by shifting to relatively higher-yielding, longer-duration investment opportunities,” said Martin Hansen, senior director, Fitch macro credit research.
Fitch’s sample set is based on public filings from the 10 largest US prime institutional and retail MMFs. For this study, Fitch defines liquid assets as MMF direct holdings of US Treasury and agency securities (regardless of maturity), and other bank and corporate exposures (including repos) with a residual maturity of one week or less.