The Ultimate Short-Term Investment Stress Test: Lessons From Covid-19
By Eleanor Hill, Editor
Treasurers were finding it hard enough to know where to invest their short-term cash before the pandemic hit. Now, the pressure is even greater. TMI speaks to five industry experts to discover how treasury professionals are responding to the financial impacts of Covid-19. We also ask what treasurers can do to ensure they have the right mix of short-term investments today, and take a look at the future of money market funds, post-pandemic.
Virtual Roundtable Participants
Eleanor Hill (EH): How has the Covid-19 pandemic impacted treasurers’ behaviour around short-term investments thus far?
Alastair Sewell (AS): The pandemic has led to several notable effects. Number one, we have seen – in a broad sense – investors moving away from riskier assets and moving into less risky assets. This includes allocations to money market funds [MMFs] and anecdotal reports of inflows to gold exchange traded funds [ETFs], for example.
Scratch the surface, however, and you see that within MMFs, the flow patterns are starkly split. Specifically, we have seen very strong inflows into government MMFs and very strong outflows from non-governmental MMFs. So much so that some managers have even suspended subscriptions – Fidelity, for example, announced that it would be limiting investors’ ability to subscribe to government-only MMFs.
At Fitch, we revised our outlook for MMFs to negative in March, which was primarily a reflection of the highly challenging liquidity environment for MMFs at that time, exacerbated by quarter end. As we’ve come into the new quarter, and initiatives such as the US Federal Reserve’s Money Market Mutual Fund Liquidity Facility [MMLF] have kicked in, sentiment has improved, as have liquidity conditions, and importantly funds – including the prime funds – have started to see inflows again.
We believe that the liquidity stress affecting funds has significantly abated now, compared with what we saw in March. However, we are starting to see fairly significant rating activity on the banks, which is where MMFs are heavily invested. As such, we’re witnessing the beginning of a new phase of stress and we are maintaining our negative outlook for now.
Will Goldthwait (WG): Covid-19 and increased market volatility have led to many new questions from our clients. We have fielded hundreds of calls and answered many queries about the cash markets and how the pandemic is impacting liquidity. We have seen treasurers mitigate risk and raise liquidity. Understandably, treasurers have heightened concerns in this unprecedented time about their ability to access their cash, all of their cash, on any given day.
Kathleen Hughes (KH): Generally, we have seen what we would have expected. The demand for MMFs and other short-dated, high quality assets increases as treasurers build up cash on their balance sheet by drawing on credit lines or accessing the capital markets. Naturally, CEOs and CFOs are unsure of the economic impact of the pandemic on their businesses, with some industries being more severely impacted than others. However, and as Alastair points out, since the start of the second quarter with capital markets opening up for some issuers and the policies to support liquidity in markets taking hold we have seen assets flowing into USD prime funds.
Dan Farrell (DF): As Kathleen alluded to, the response by treasurers to the pandemic has been, in many ways, unique to their individual firms. However, we have seen many companies use pre-arranged credit facilities to fund their operations. This has, in turn, led to an increase in cash within the system and a greater need for counterparty diversification. From an overall investment perspective, we have also seen a definite flight to quality, with many US-based investors moving into public debt MMFs.
Tom Knight (TK): The main thing we’re seeing is that there isn’t the sheer panic that we saw in 2008, and rightly so. The environment today is far different from the financial crisis. First and foremost, the current situation is not a true credit crisis like it was back then, banks and companies are far stronger this time around and governments have put their weight behind these markets for further assurance. What’s also helped is that technology has evolved to assist treasurers in making quick decisions and being proactive with their investment choices. As an example, at ICD, we offer analytical transparency into the underlying assets of funds – a capability that didn’t exist in 2008. In addition, being able to access alternative investment options from a single platform without having to establish additional accounts provides a means for treasurers to react insightfully and quickly, rather than making hasty decisions based on fear and uncertainty.
EH: While there have been inflows, there have been redemptions too – so how have MMFs held up? Did the recently introduced MMF reforms do their job?
WG: The market was moving so quickly in March that, sometimes, it was hard to keep up with it as well as the speed of the news flow. There were challenges around pricing certain bonds in the portfolio. The pricing services were under considerable pressure given the speed at which the market was moving and prices were changing. Our portfolio managers were very diligent in finding liquidity and utilising all of their relationships to source the best price for assets that needed to be sold.
For US-registered funds, we saw elevated redemptions from US prime institutional MMFs and large inflows into US Government and Treasury MMFs. In our Dublin-domiciled funds, flows were quiet in the GBP and EUR funds but the USD funds saw outflows. Fortunately, liquidity levels were maintained and regulatory limits were upheld.
DF: As we all know, following the 2008 global financial crisis, regulators identified MMFs as integral to financial markets and as a result introduced new regulatory requirements. The regulations were designed to protect investors and ensure funds can weather future stress events and continue to provide daily liquidity to investors. MMFs have adhered to these changes while continuing to provide what is important to investors in the current market environment, capital preservations and daily liquidity.
As Will highlighted, the US domestic market has seen assets under management [AUM] meaningfully shift from prime to government or public debt funds, but – in our view – the offshore MMF industry has not witnessed the same trend across all currencies or to the same extent. While offshore US dollar-denominated funds did experience outflows, we did not see the same trend in euro or sterling-denominated funds, mainly for two reasons.
First, fund structures are different: European investors can access LVNAV funds that can provide a NAV of 1.00, while in the US, VNAV is the only option for prime funds for institutional investors [retail prime funds are still CNAV]. Secondly, investor options are reduced: the euro, sterling and US dollar public debt market is a small proportion of the European market, compared with the US market.
AS: It’s an interesting question. Despite our negative outlook, we do think funds are well positioned and that the industry is generally in robust shape – this is in no small part due to the recent reforms. Funds are running very high liquidity now, which means they have a good ability to adjust their holdings and exit any issuers which may face credit difficulties.
We can’t really compare the current situation with the global financial crisis of 2008, as the causes were so different. But funds are certainly in a much stronger position now. One interesting behaviour we saw, was that the funds were less willing to use their weekly liquidity bucket to meet redemptions. So, rather than allow their weekly liquidity to fall, they would use daily liquidity – obviously part of weekly liquidity – rather than letting their weekly liquidity dip below 30%.