Vanguard Group’s move to convert its prime fund to one buying government bonds by the end of September will pull US$125-billion from the remaining US$750-billion invested in the prime segment.Nikada/iStockPhoto / Getty Images
Some of the world’s largest asset managers are shutting down U.S. investment vehicles that have suffered rapid outflows in times of stress, threatening an important source of short-term funding for companies across the U.S.
The Vanguard Group followed peers Fidelity Investments Inc. and Northern Trust Corp. last month when it announced the closure of its “prime” money market fund. Such funds, which invest in corporate, agency and other debt with a maturity of less than one year, are seen as a more freewheeling variant of government money market funds, which invest solely in sovereign securities.
The asset manager’s move to convert its prime fund to one buying government bonds by the end of September will pull US$125-billion from the remaining US$750-billion invested in the prime segment. The switch comes after prime funds experienced heavy withdrawals in March, ricocheting through the funding markets they invest in and prompting the U.S. Federal Reserve Board to step in to restore order. Some analysts are now braced for a regulatory clampdown on the sector.
“The rewards of prime funds are no longer worth the risk,” Vanguard states.
Vanguard’s prime funds dropped by almost US$4-billion in March, marking the heaviest month of outflows since October 2016, as coronavirus fears spread across riskier asset classes from equities to credit. Fidelity says its institutional prime funds fell by about a third, to US$12.5-billion, over the course of the month.
Overall, prime fund assets plummeted by US$140-billion to US$654-billion during the month, according to data from the Investment Company Institute. Meanwhile, government money market fund assets rose by over US$700-billion.
Heavy withdrawal requests can pose a big challenge to the managers of prime funds, who promise investors ready access to their cash – even though they are buying assets that can be hard to sell in volatile conditions.
“Typically, what we see in times of stress is institutional investors rapidly moving from prime funds to government funds. We saw this again in March,” says Nancy Prior, president of Fidelity’s fixed-income division in Boston. Fidelity will continue to offer prime funds to retail investors, who it says were less likely to pull their money out in times of turmoil.
Similar scenes played out in September 2008, when investors yanked US$400-billion from prime funds amid fears over Lehman Brothers Holdings Inc.’s solvency and corporate borrowers’ ability to repay their debts. The Reserve Primary fund, which shepherded more than US$60-billion at the time, “broke the buck” as the net asset value of the fund slipped below US$1 a share. The episode scarred prime funds’ reputation as a safe place for investors’ cash.
In 2016, regulators introduced stringent new rules for prime funds, including the ability for fund managers to temporarily prevent investors from withdrawing their money.
But Fed economists argued in July that those rules may have actually exacerbated outflows from prime funds in this year’s sell-off by pushing investors to try to get hold of their cash at a faster pace.
“Given the notable role of [money market funds] in the short-term funding markets and in the shadow banking system, more research and collaborative regulatory efforts are warranted to enhance the stability of the industry,” they concluded.
Joseph Abate, managing director at Barclays PLC in New York, expects increased scrutiny over the size of the funds’' liquidity buffers, holdings and the eligibility of investors.
There could be more immediate effects, too, if fund closures curtail a vital source of short-dated financing for companies. The commercial paper market – where companies borrow for up to 12 months and where prime money market funds are among the largest players – was rescued in March when the Fed set up a special purchasing program to stave off a funding crunch. The U.S. central bank also launched a facility that made loans to banks secured by assets from money market mutual funds, in order to ensure that they could meet demands for redemptions.
Corporate treasurers have responded to the squeeze on funding, reducing their reliance on short-dated debt by increasing the maturity of their borrowings. The total amount of commercial paper outstanding in the U.S. has sunk from US$1.13-trillion at the beginning of the year to less than US$1-trillion in September – the lowest in three years.
Some analysts say that investors will continue to be drawn to the higher returns that prime funds offer, despite the risks. Pete Crane, who runs the money market fund data service Crane Data LLC in Westboro, Mass., says reports of the death of such funds are “greatly exaggerated,” adding: “Yield always wins over safety, eventually.”
But others are not so sure. If interest rates remain on hold, spreads – the additional yield available on credit over U.S. Treasuries – shrink further, and another round of regulation makes running these funds more onerous, “it is possible you could see another round of ... closures,” says Mark Cabana, a strategist at Bank of America Corp. in New York.
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