The ACT recently hosted a webinar and welcomed three experts from Aviva Investors, Anthony Callcott, Global Head of Liquidity Client Solutions; Caroline Hedges, Global Head of Liquidity Portfolio Management, and Mhammed Belfaida, Portfolio Manager. The session was chaired by James Winterton, Associate Director, Policy & Technical.
In this webinar, the panel shared their insights on the current rate environment and the implications of monetary policy on money market fund yields.
Please click here to watch the recording of this webinar.
Following the event, Aviva Investors has kindly responded to a number of the questions raised by the audience.
Source : Bloomberg data, based on Bloomberg Barclays Global Aggregate Negative Yielding Debt index, in USD.
In our experience, this hasn’t been the case at all. In March, we were thrown into a world of adjusting to working remotely, home schooling for many and severe volatility in the markets. The intensity of this new working environment meant we had to adapt very quickly to deliver the same seamless experience and level of service expected by our clients.
Face-to-face meetings and teams being able to collaborate in the office were immediately replaced with virtual platforms. But far from reducing our interaction and communication with clients, we actually increased interactions to maintain that level of comfort clients needed in an investment world dominated by unprecedented central bank and government action. You could argue this forced productivity to increase.
The current gross yield on the Sterling Liquidity Fund is 16bps. We are putting together, a piece on performance versus peers and how we have achieved consistent outperformance. Once published, we can share this with you.
Although negative nominal and real rates both have a stimulating effect on the economy, there are operational challenges to negative rates that could have unintended consequences. It is these consequences the Bank of England are investigating thoroughly before they make the move to negative rates in the UK. This work could prove useful for other central banks should they need to go down this route in the future.
The 20bps collar is broken when the market-to-market value of the fund goes to 0.998 to 1.002.
The Bank of England is aware of the importance of money market funds in supporting the real economy by providing liquidity, as are other public bodies that have spoken out recently on the volatility that MMFs faced early in the COVID crisis.
During March and early April, there was significant dislocation in all markets (including MMFs), creating volatility that drove an exodus from funds. We saw large corrections in equities, fixed income, currencies, oil and commodities, caused by a short-term loss of confidence rather than a fundamental shift away from assets. No market was immune from volatility. This led to redemptions on MMFs for a short time, notably in USD funds. Euro and Sterling MMFs had stable or increasing NAVs due to net subscriptions during this time.
Importantly, unlike other markets, European MMFs did not have support from the central bank during this time (the US Federal Reserve did create a facility to support US-domiciled MMFs). However, there was large-scale support to other markets, including repo facilities, bond purchase schemes, commercial paper facilities to fund corporates and extensions to schemes to support cheap funding for banks to ensure they continue to lend.
The European MMF regulations of 2019 were the result of many years of hard work, designed to enable MMFs to continue to meet investors’ need for capital preservation and liquidity, even during times of extreme turbulence, as we saw earlier in the year. This was a real-life stress test of the regulations.
Yes, they did. In fact, not only did MMFs meet large redemptions from clients in USD liquidity funds, but they were also able to bolster their liquidity buffers. That is testament to the agility of MMFs to adapt to stressed environments. With very short WAMs/ WALs and a regular and constant supply of maturing assets, MMFs can simply not renew their asset maturities daily to bolster liquidity during times of stress.
Should negative interest rates come to the UK, it’s worth remembering the concept is not new. Sweden, Denmark, the ECB and Japan have all introduced negative interest rates on deposits over the past ten years or so; hence there is precedence for what banks do on the back of this.
In practice it is not “mass” retail savers who will be captured, but typically commercial lenders, large corporates and SMEs (and, at a push, HNWI clients).
Given the macroeconomic disruption from COVID-19 (and potentially Brexit) politicians – and we would include the Bank of England here – want banks to lend and mechanisms need to be in place to allow this, including for borrowing even in a negative rate environment. There should be no presumption banks will have to be “equitable” in this regard. That is highlighted by the fact recent rate cuts have not fully “passed through” to mortgage borrowers.
While we have seen negative interest rate mortgages (Jyske in Denmark last year), that’s the exception and not the rule. In the UK, we’ve seen an increase in two-year fixed rates over the summer, reflecting demand-supply imbalances in banks’ favour. If anything, the low rate environment appears to be driving a longer-term market (as seemingly is being pushed by the government), which will simply extend the margin banks can charge.
Finally, banks have a duty to all stakeholders – not just politicians, regulators, central banks and customers, but also their shareholders. Their ability to generate returns (presuming dividend restrictions ease) are paramount in the period ahead to ensure access to capital should pressures escalate beyond our current expectations.
In the event of a bad Brexit or no deal Brexit, there is an expectation that further stimulus will be needed to offset the negative impact; firstly through an increase to QE and, potentially, a reduction in the Bank of England base rate. The latter is not a certainty as the jury is out on the benefits of negative interest rates on the economy. We know banks’ profitability is impacted by negative interest rates due to the difficulty is passing these onto depositors (one of their main funding channels for activity), reducing their margins.
This impact can be lessened by other measures (such as the TLTRO in Europe, which allows banks to borrow at very favourable rates below the ECB deposit rate), and increasingly we are now seeing banks pass on negative rates to corporate and retail depositors. Recently, the Bank of England and FCA have been speaking with banks and financial services firms to understand their readiness for negative rates.
However, the desire to move below zero, which the BOE once said was not a tool in its policy response toolkit, has created a conflict of opinions within the Monetary Policy Committee itself. This is not a done deal.
We do expect, however, that the MPC will look through overshoots (above target) inflation. This would follow a similar strategy to the Fed, where it would instead assess long-term average inflation when assessing whether to raise interest rates to prevent the economy from running too hot. It is unlikely we will reach the point at which interest rates rise for 4/5 years – let’s not forget that we have had negative interest rates in the euro zone for six years and they are still battling with deflation.
Fund providers may reserve the right to sacrifice the management fee to offset a clients’ negative yield for certain periods. But this is very much done on a fund-by-fund basis. And the fund provider needs to make its own commercial discussions as to what is appropriate and how they could support that. Ultimately an asset manager would only be able to withstand an erosion of the management fee on a short term basis given the commercial implications this offset would bring. This is why accumulating share classes may become the norm as we navigate through a negative rate cycle. This will allow the client to continue to administrate and process the impact of negative rates and allow the fund provider to retain a management fee for the service provided.
MMFs are well prepared for negative rates from an operational point of view: a net gross yield would mean that a distributing share class of an LVNAV MMF would need to move to an accumulating share LVNAV share class (closing the distributing share class) or convert to VNAV.
Large net outflows are extremely unlikely to happen in this scenario, as clients have few alternatives in which to place their cash. Additionally, deposit rates are likely to follow interest rates negative. After years of negative interest rates from various central banks globally, there has been a huge shift in the mentality towards them. The prospect is not as uncomfortable as it once was and, with banks and corporates operating with excess liquidity, it is unlikely we will see a material shift out of MMFs.
Importantly, the new regulations require MMFs to hold excessive amounts of overnight and weekly liquidity to manage redemptions. MMF providers would only implement fees/gates as a last resort. The COVID crisis has proved how agile MMFs are in their ability to adapt to changing market conditions – we saw liquidity buffers increase to over 50% for many funds. This agility dramatically reduces the likelihood of fees/gates in a scenario of large outflows – MMFs are there to provide clients with liquidity and have proved that they are able to do just that, even when faced with large daily redemptions.
However, if gating were to occur, such measures would be in place to protect the interests of all shareholders – preventing a first mover advantage of shareholders redeeming before others in a severe negative event scenario.
The 2019 European MMF regulations give treasurers even more transparency on what funds are holding and who they have lent money to, including through a weekly holdings report that is published online. Clients want to know the asset allocation of funds, in terms of maturity, rating and asset type. Clients understand that the AAA-rated MMF will invest in highly liquid and highly rated securities; they would not expect the fund to have a 100% allocation to AAA securities, which would be hard to achieve even within a fund exposed solely to government securities. And the days of AAA-rated banks are a thing of the past, even though, conversely, they are far better capitalised and hold more liquidity now than they did before the financial crisis, when they were rated higher.
AAA-rated MMFs are unable to take on additional risk to seek a higher return, as the fund ratings have stringent assessments in terms of liquidity and credit risks. There are many EUR MMFs that don’t have AAA ratings and take on significant credit risk (investing down to BB+ and below) to achieve a higher potential return for clients. However, the current policy regime from the ECB has led to credit risk premium being priced out of the market. As such, the return on non-AAA-rated MMFs and AAA-rated MMFs are not that dissimilar.
If clients target a higher than MMF return, towards 0%, our solution to this would be for the client to take a more sophisticated approach to managing their cash. They could do this by segmenting it into different portfolios, with their day-to-day cash requirements met with a same day MMF; their 3-6 month cash requirements met with a Liquidity Plus Fund; and an allocation of their cash that can be invested for 12 months invested in a fund that meets that criteria. By employing this type of strategy, the client does not lose out on the liquidity and capital preservation they need, but it also meets their higher return threshold.
The stated aim of an MMF is to maintain security of capital alongside fulfilling liquidity requirements and presenting a yield over benchmark. It would not be the intention for any capital to be at risk. When you invest in a MMF, not only are you diversifying your risk (as opposed to a concentrated risk of investment in cash deposits), but you also invest in the credit capabilities of the asset manager to deploy your cash in highly liquid and fundamentally sound companies and issuers. You are selecting managers for their experience (long-term with a great track record) and their ability to price risk and to not put your capital at risk. Treasurers are able to outsource this sophisticated credit analysis to asset managers for a very small management fee and achieve liquidity and yield at the same time.
