A team of Invesco analysts explore the options for treasury teams seeking to navigate negative rates in money market funds. They note that standard money market funds can take on more risk but caution against so-called ultra-short and cash plus funds.

As the financial return for corporates putting money in European money market funds (MMFs) remains moribund, experts from Invesco’s global liquidity team ponder the current options for treasury teams seeking the preservation and same day liquidity of a MMF. These funds, which buy short-dated assets to provide clients with a safe and liquid alternative to cash have an investment horizon that ranges from overnight to lengthier time scales. And corporate demand is strong despite negative rates.

When interest rates turned negative in euros over six years ago, many corporate treasury teams moved away from MMFs in favour of bank deposits that were able to continue offering a positive or zero yield. But as the industry has adapted to negative yields, banks have started passing the negative yields on to clients too. “Looking at the AUM in short-term MMFs we’ve seen a vast increase in AUM being invested during 2020. For those who do place high importance on preservation of principal and liquidity, negative yields haven’t necessarily caused them to change their investing habits,” says Natalie Cross, Senior Client Portfolio Manager at Invesco.

Standard or short term?

The European money market is composed of “standard” and “short-term MMFs. Standard funds can take on more risk, which makes them potentially attractive in Europe, given the prevailing negative interest rate environment. Standard MMFs are typically not rated, while short-term MMFs are, says Invesco.

Standard MMFs tend to use the ability afforded to them under current regulations to take greater spread and duration risk than short-term funds. MMFs also typically buy lower-rated issuers than short-term money market funds and may invest in longer-term securities.

Europe’s other cash management alternatives for corporates comprise “ultrashort” or “cash-plus” funds that are less regulated than MMFs and often take on more risk than MMFs. “Given these additional risks and our focus on “return of principal,” we believe it is important to do one’s homework when it comes to these funds’ investment strategies and not to mistake them for money market funds,” warn the Invesco team.

Rate hikes?

Money market yield curves are very flat in Europe, making it difficult for MMFs to generate yield. Recently, there has been an uptick in market expectations for US policy rates, given the recent outcome of the US election, improving macro data and the ramping up of the COVID-19 vaccine rollout. So, it is not surprising that futures markets are starting to price in Fed rate hikes in the second half of 2023. Things are very different in Europe, where no one expects rate increases for a long time, inflation is stubborn, the vaccine is rolling out slowly, and the macro-outlook is subdued.

Treasury teams looking to achieve a positive yield in the European money market fund universe, need to consider a five-year maturity and the lower-rated end of investment-grade securities, suggest Invesco. Alternatively, they could tap the high yield market and avoid having to take on as much duration. “Achieving a yield above zero in euros is still possible,” say Invesco analysts. However, choosing longer maturities and taking considerably higher duration risk might not be appealing to some corporate treasury teams. Invesco also points to opportunities outside of the money market fund universe – particularly if short-term investors can go down the capital structure. By doing this, treasury teams can potentially pick-up attractive yield versus Euribor in the European investment grade market.

Here Invesco suggests treasury teams consider things like subordinated corporate debt. Or subordinated financials, for example, Tier 2 financials versus senior financials. The spread dispersion is still quite substantial. And moving further out to additional Tier 1 bonds offers further pick-up in the spread versus senior financials, say Invesco analysts.

When jumping from MMFs to shorter-duration strategies, Invesco counsels on the importance of liquidity. Shorter-duration funds will tend to face greater volatility in returns and lower liquidity versus MMFs. But they still invest in high-quality securities and focus on risk-adjusted returns with a similar risk profile to money market funds. The type of investor and the uses of cash also help determine whether a money market fund or ultrashort strategy is appropriate. For example, can the investor take mark-to-market risk? If the cash is needed for operational purposes, for example, to pay dividends or salaries, it may not be suitable for strategies outside of money market funds, they conclude.