Despite a drop-off at the end of the year as increasingly confident investors shifted their focus to equity and fixed income funds, 2023 was a good year for money market funds (MMFs).

According to data from global funds network Calastone, a combination of high interest rates and low risk saw MMFs absorb a record £4.38bn of capital last year, more than in the previous eight years combined.

ECB data shows that total assets of euro area MMFs rose by 12.5% last year and analysis by fund flows and asset allocations data provider EPFR suggests global MMFs have continued to do well over the first three months of this year.

This view is supported by the actions of corporates such as Dr. Martens, which uses a combination of MMFs and overnight/term deposits with its approved banks to manage short-term cash and maintains a small buffer on key operating bank accounts.

“Our general aim is to minimise idle cash and by doing this we earn interest on our cash balances while maintaining a high level of liquidity,” explains Mark Hirst, Group Treasurer. “Money market funds are a great way to diversify our cash across pre-selected, high quality pre-approved counterparties.”

The company is very clear with key stakeholders in the business that this approach is never completely risk-free, but that they should typically think of these investments and the funds as very safe and stable.

“We favour low volatility funds,” says Hirst. “These investments are short term in nature and we can withdraw or redeem our money on demand.”

Performance is reviewed every month and reported via Dr. Martens’ monthly treasury management information pack. “We keep a close eye on the credit quality of fund companies and their funds and every six months or so we invest time in researching new funds to understand if they meet our needs,” adds Hirst.

MMFs also play a key role in American Honda’s investment strategy. “Due to the nature of our operations and the liquidity role we play in the company, our portfolio is kept very liquid,” explains Kim Kelly-Lippert, Manager of Treasury Operations. “As such, most of our cash is invested in bank deposits and money market funds. Money market funds provide us with easy access to liquidity as we have the option to redeem from the funds as often as needed.”

The company is currently investing in government MMFs that due to the nature of the investments are high quality, carry a stable net asset value, and are very liquid. It also uses a wide variety of funds that give it the opportunity to diversify its portfolio per the requirements of its investment guidelines. Unlike the bank products, the funds are broadly diversified and American Honda is not subject to the individual credit exposure.

“For day-to-day management of the funds, we compare and review the metrics of each fund and make the decision on where to purchase or redeem,” says Kelly-Lippert. “We trade through the ICD Portal, which is integrated through API to our treasury management system Kyriba and the upload is fast and easy which creates higher efficiency for trading funds. With the upload, all our trade tickets, positions and reporting are updated automatically.”

The company also uses the information provided on the portal for data reporting and analytics, running reports and reviewing the detailed portfolio holdings information and fund metrics provided by each fund group.

“We take an even deeper dive each month into the portfolio holdings by using the reporting information from the portal, which combines money market fund holdings and direct holdings where we can look at our overall exposures and underlying credits,” says Kelly-Lippert, who adds that the company is comfortable with its current allocation.

“With the choice of using government money market funds it is not really a credit issue, but more about rates, portfolio structure and relationships,” she says.

Many corporate treasurers are taking a more critical look at their investments in the wake of last year’s US regional banking crisis with an eye towards heavy concentrations with individual counterparties suggests Sebastian Ramos, EVP of ICD Portal.

“Much of the new issuance has been around D&I initiatives for corporations wanting to make a social impact while also earning a competitive return,” he says.

According to Dan Farrell, Head of International Short Duration at Northern Trust Asset Management, treasurers are asking two key questions – how long central banks will keep rates at current levels before cutting, and what the pace of cuts will be when they start.

“Naturally, astute treasury teams are looking to maximise the short-term investment opportunities available to them while maintaining liquidity and security,” he says. “In terms of product innovation, the journey toward longer maturities can extend beyond cash or money market products into the ultra-short strategies that can enhance investors’ high quality, short duration exposure.”

The main difference between bank deposits and MMFs can be seen when rates are falling. MMFs can purchase securities with longer maturities to stagger the effects of the rate reduction and by retaining higher yields over an extended period can provide more appealing returns than short term bank deposits.

Central banks have been gaining confidence that their tightening cycles are impacting inflation, but they require further information before they can declare victory. The last mile in getting inflation down to 2% is proving stickier than the market expected, leaving central bankers vindicated for erring on the side of caution.

“We continue to believe that the question central banks face is how long to remain restrictive rather than how restrictive they need to be,” says Farrell. “Further information on inflation and wages is required before they will be comfortable commencing their cutting cycles, but they look most likely to begin at the end of Q2 for the Fed and ECB and start of Q3 for the Bank of England. The path beyond the first rate cut will continue to be data dependent, where central banks could approach the cutting cycle cautiously.”

Kim Hochfeld, Head of Global Cash Business at State Street Global Advisors describes current treasurer appetite for MMFs as being at a level that would only expect to be seen once or twice in a career.

“To put that into context, an estimated US$1trn left bank deposits in the US alone in 2023 and went into money market funds,” she says. “Global rate rises led these funds to outperform bank deposits while offering a more diversified credit exposure within an AAA-rated wrapper. It became a very practical, obvious choice for most treasurers to use a money market fund for excess liquidity.”

Over the last 12 months a number of providers have introduced funds classified as Article 8 funds under the EU’s Sustainable Finance Disclosure Regulation.

“At a high level, these funds also seek to invest the majority of the fund’s capital into sustainable investments and apply negative screens to the portfolio so that they do not invest in issuers that violate certain international norms or are involved in certain business activities,” says Hochfeld.

State Street Global Advisors has also seen investors increasingly likely to consider sterling and euro government funds. Until this point in the rate cycle there had been extremely low demand for these solutions but treasurers now have the choice of whether to dial up or dial down risk in their liquidity investments while still earning an attractive yield.

“With dollar excess cash sitting in a money market fund yielding as much as 5.5%, even traditionally riskier asset classes have struggled to attract flow,” says Hochfeld. “It is a very low risk security to buy in the context of a volatile investing environment.”

During previous interest rate cycles, money has stayed in MMFs until central banks stabilised rates and then gradually moved out as rates fell. There is an interesting nuance though in that money market funds tend to buy longer dated paper.

“As a result, they are generally able to offer more competitive yields than what banks are able to pay on their deposits in a falling rate environment,” adds Hochfeld. “That means that money market funds tend to outperform bank deposits for a period, remaining competitive for longer.”

The majority of the change within the sector has occurred within portfolios as holdings have shifted from significant repo allocations to US Treasury Bills says John Donohue, Head of Global Liquidity at J.P. Morgan Asset Management.

“We expect to continue to see consolidation in the tax-exempt sector,” he adds. “On the digital/blockchain front we will continue to see managers experimenting with new technologies. However, those projects will take time and resources to gather more interest.”

Donohue reckons improving macro outcomes likely means less cuts than the market is currently expecting. “A modestly declining or higher-for-longer rate environment should continue to keep money funds attractive in 2024 and beyond,” he says. “Depending on where bank deposits are priced, we may continue to see money market funds taking market share from bank deposits for the foreseeable future.”

MMF returns are determined by their very conservative investment decisions, as it is not the return on cash that is paramount but the return of cash. Therefore, returns will generally underperform those of funds that take more investment risk when market conditions are conducive.

The extent to which interest rate movements and market volatility impact MMFs in Q2 and beyond will depend on the severity of these rate movements and market volatility and how investors are positioned or react to them explains Kush Sondhi, Client Portfolio Manager at Invesco.

“As conservative and very short-dated duration funds invested in very high-quality securities, money market funds can manage interest rate events very well. Market volatility may have more of an impact on flows but these can be managed through a well-diversified and laddered maturity profile.”

Alastair Sewell, Liquidity Investment Strategist at Aviva Investors refers to increased demand across currencies, noting that as of mid-March the average sterling low volatility net asset value MMF was yielding 5.35% gross, a premium over the interbank rate of 5.19%.

Reduced central bank rates will ultimately feed through to MMF yields, but Sewell says history shows there will be a lag. “Going back to 2014 there was roughly a one year lag between market rates turning negative and money market funds yields turning negative, largely due to funds’ ability to ‘term-out’ their assets,” he says.

According to Sewell, the innovation the market is waiting for is around tokenisation. “There is no reason why a tokenised commercial paper could not settle near-instantly, which would be a significant benefit to money market funds by reducing the time between trade instruction and delivery of trade proceeds,” he concludes. “But while there have been some interesting early developments, broad adoption still seems a way off.”