Every U.S. treasurer who parks corporate cash in money funds should already be well aware of the regulatory changes taking effect this Friday. Prime money market mutual funds will have to shift to a floating net asset value (NAV), and the funds' boards will have to consider implementing redemption fees or gates if liquidity falls below specific levels.
"This is a big change," says John Donohue, head of global liquidity for JPMorgan Chase. "It's one of the biggest changes that's ever happened in this space."
Donohue downplays the effects of the floating NAV on corporate investors. "While the NAV is floating, the funds will still be subject to the same investment guidelines they always were subject to," he says. "So if the NAV does float, it's going to be with very, very low volatility. These funds have always floated, they've just floated in such a narrow band that they've always rounded up or down to par."
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He sees the prospect of redemption fees and gates as a more pressing concern for corporate investors. "Our institutional clients do not like gates and fees," Donohue says. "That is probably a bigger hurdle for them than the floating NAV. Those gates and fees are there to protect shareholders and make sure everyone's treated equitably. But corporate investors are concerned that the gate will go down at the exact time they need their liquidity, because if they are going to be implemented, it will be at times of stress."
Since 2015, the total assets in prime money funds have fallen by about $825 billion. Over the same time, total assets in government funds ("govies") have increased by about $850 billion. JPMorgan's U.S. government money market fund has more than doubled in size in just a few months, from $66 billion on July 1, 2016, to $150 billion in assets under management today.
An Association for Financial Professionals (AFP) survey released in July showed that 30 percent of finance executives would not invest in prime funds after the new rules take effect, no matter what yield spread prime funds offer over govies. However, a quarter of respondents said they'd park cash in prime funds for 25 basis points more yield, and 50 percent would do so for an extra 50 bps. In both scenarios, spreads are considerably higher than the historically typical yield differential of 10 to 15 bps.
"At some point," Donohue says, "you would expect that there would be a risk-and-return dynamic that might cause money to move from govie into prime, as institutional clients feel that they're being compensated for the extra risk and operational hassle of having a floating NAV and potentially a gate and a fee.
"I think managers are going to do everything in their power to structure [prime] funds so that the probability of a gate and a fee happening is minimized," Donohue adds. "That doesn't mean it never will happen. But it'll be like 'breaking the buck' is now: It could happen, but managers manage the funds so that there is a very low probability that it will happen."
He points out that fund managers' disclosures are much more robust than they were a decade ago. "Weekly liquidity and daily liquidity—it's all going to be posted on public websites for clients to see in real time," Donohue says.
But for companies that are still uncomfortable with investing in prime funds after Friday, Donohue emphasizes that other options are available. He sees a lot of JPMorgan clients interested in ultra-short bond funds and separately managed accounts.
"Once you're comfortable with credit and you're looking to get paid to take a little bit more credit and/or duration risk, you can move out to an ultra-short bond fund (we call it 'managed reserves' here at JPMorgan)," Donohue says. "You're going to get a historically attractive return over a govie fund or even a prime money fund. You'll have a floating NAV, but typically it's a reasonably low-volatility NAV because they're ultra-short funds and not subject to gates or fees."
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