March 2020 will be in the history books as one of the most turbulent on record for most of the planet. As the full realisation has hit home of what the COVID-19 pandemic means from a social and economic perspective, individuals and organisations alike have been justly concerned.
Whilst the healthcare emergency continues, and the economic impact is contemplated, corporate investors have taken stock and are now necessarily building cash cushions and raising liquidity in the capital markets, with many also drawing down credit lines to strengthen their cash buffers.
It’s perhaps not surprising then that in the US, our government money market fund rose from US$60bn to US$105bn in around four weeks. In an exodus from equities and other assets that exhibited something of a herd mentality, this tectonic shift was mostly new money too, with many investors exiting Prime funds in their flight to safety.
The trade-off to ensure essential liquidity at this time has inevitably been yield. However, at the beginning of March, even liquidity for US treasuries looked strained. It’s now clear that corporate treasurers have to start thinking about how best to manage liquidity with their eyes wide open.
Asset managers, certainly following recent regulatory reform in the US and Europe, are well-versed in stress-testing and scenario planning. But corporate treasurers now also need to be thinking along similar lines if their aim is to build a portfolio that meets their needs.
Where gaining incremental yield has been a driver, Prime portfolios were the corporate cash-bucket of choice for many. In highly stressed times, such as now, government funds have become the favoured lower-risk destination, hence the flight in recent weeks.
Indeed, with the apparent shift from Prime was not good for the fund, fund manager, nor for investors – treasurers have had to reconsider whether this is the cash-equivalent that really works for them right now, especially considering Prime (which invests in non-treasury floating-rate debt and commercial paper) has a credit component.
As ever, it’s a case of investing only when in possession of the facts and an understanding of the potential risks. Some do not. With State Street Global Advisors handling a significant number of client calls since March, it nonetheless came as a surprise that some investors still struggled to feel comfortable with a floating NAV fund, and that the concept of ‘breaking the buck’ is no longer applicable.
But this is perhaps understandable given the scale of MMF reforms implemented in 2016 in the US and 2018/2019 in Europe.
Fortunately, whilst some investors still exhibit signs of nervousness over core liquidity in the market, as evidenced by the growth in government funds, many now appear to be at a reflection point in terms of where their portfolios should be in the current phase.
Understandably, the hunt for yield still seems to be in abeyance, with treasurers not taking the risk of getting into credit or taking on longer tenors. Fund managers too have to be cognisant of the potential for a ‘second leg down’ scenario, in which the initial perception of liquidity risk could, if it continues, morph into credit risk. Deep trouble in the oil and energy sectors in recent weeks, for example, indicates that the threat is real for banks and corporates, and thus some funds, with deep exposures here.
The choice of assets for investors with longer-term cash that do not share the herd-mentality may feel justified in allocating it to a Prime fund or an enhanced cash fund, knowing they can ride out the storm. There are a number of investments beyond a six-month tenor in high quality banks, where the pricing is still deemed advantageous, and these could still be in the mix.
Investors looking to protect their principal, and maintain liquidity, can still seek out government funds, but short duration and enhanced cash Prime funds are available; investors just need to be conscious of their credit component.
For investors in low volatility net asset value (LVNAV), where asset value cannot deviate by more than 0.2% from par, raised risk awareness is also required. For treasurers who understand and stress-test their cash flows, these can be worth considering if they want to participate in Prime or short-duration funds and they see a gap opening up between the two strategies.
Certainly, the current environment is difficult. But fund managers are keeping significant liquidity and remain prudent in terms of potential ‘second leg down’ risk. For State Street Global Advisors, the unprecedented market-wide stress seen in early March required no support from our fund parent. As such, our money market funds’ ideas and principles remain intact.