Are money-market funds really on decline?
Christian Dargnat, president of the European Fund and Asset Management Association (Efama) and CIO at BNP Paribas IP, argues that relative, rather than absolute returns, prudential regulation of banks and investors requirements are three reasons for the continuing popularity of money market funds.
Global asset management accounted for assets of almost USD 64 trillion in 2013 or 25% of world financial assets. This is expected to climb to nearly $100,000 billion by 2020 on the basis of the current economic and demographic outlook. In a context where the development of asset management has been subject to some upheaval, it seems important to challenge three preconceived ideas which currently shape the general consensus. Let’s start with the future of money-market funds.
The current environment of negative short-term interest rates has led many observers to the conclusion that a decline in the role of money-market funds is inevitable. The rationale for their view appears at first sight coherent and hard to refute, “a product that potentially offers negative yields is basically doomed to disappear”.
The reason for the misguided reasoning lies in the reference point being used. The absolute measure in finance has generally been accepted as the zero yield – a big mistake. Just as temperature is measured in degrees Celsius, the absolute measure in physics is the Kelvin degree. Although water freezes at 0°C, matter can interact down to -273°C, the quantum zero-point.
Economic models generally use zero as the lower bound for the risk free rate. Yet, when abundant liquidity meets with an environment of very low inflation or even deflation, the benchmark is likely to break this psychological barrier and can theoretically fall to the total destruction of capital, -100% , the financial quantum zero.
Corporate treasurers have a limited range of choices
In the case of money-market funds, a relative, as well as an absolute reference point should be considered: the central bank’s deposit rate. Institutional investors are behind 72% of the assets invested in money-market funds. A corporate treasurer is obliged to ensure that the lion’s share of the company’s available cash is invested in assets offering daily liquidity. He has two main options: bank deposits (within the limit of his individual bank exposure risk) and money-market funds. As long as money-market funds offer returns that are relatively attractive compared with the rates available on bank deposits (these being indexed to the central bank’s deposit rate) there is no reason why money-market funds should disappear.
Money-market funds should benefit from new regulation
Moreover, the direction in which regulation of banks is evolving appears favourable to money-market funds. The new prudential regulation of banks (liquidity coverage ratio(LCR) and net stable funding ratio (NSFR)) encourage banks to hold assets with a maturity of greater than one year on their balance sheets. In terms of assets the possibility of daily repurchases of bank deposits automatically leads to an unattractive remuneration profile as they are not taken into account in the calculation of these ratios. Money-market funds on the other hand provide a solution in two ways. While operating within a very strict regulatory framework, money-market funds enable liquidity and maturity transformation while respecting daily liquidity requirements and offering a relatively attractive return compared with deposits. Their existence gives rise to in investments in short-term debt which ultimately contributes to the financing of European companies.
The economic benefits of these investment products in providing financing for the economy are now widely recognised. At the end of 2013, the economic value of these investment products (money-market funds), was, according to the European Commission, EUR 1,053 billion in Europe and permitted financing of 38% of short-term issuance by banking institutions and 22% of issuance by sovereigns. It is therefore an essential investment channel, supporting the European economy and permitting access to capital for corporates both via capital markets and through bank intermediaries.
A relative reference, prudential banking regulation and investors’ needs are three good reasons for believing that assets in money-market funds will not diminish; on the contrary, thanks to their specific qualities, they will remain an essential factor supporting the European economy!