Euro money market funds’ (MMFs) yields have stabilised at marginally positive levels two months after the European Central Bank (ECB) cut its deposit facility rate to zero, according to Fitch Ratings. The credit ratings agency (CRA) said that MMFs could nevertheless post negative yields if short-term euro market rates move further into negative territory. This would not be a negative rating factor per se for Fitch-rated MMFs. It would, however, lead fund managers to review their investment objectives and fund structural features.
Negative MMF yields stemming from the short-term market rate environment would not be a negative rating factor per se for Fitch-rated MMFs, including for those rated at AAAmmf. Fitch said it recognises that MMFs yields are to be consistent with prevailing safety and liquidity costs, commensurate with alternative high-quality short-term instruments, such as ‘AAA’-rated euro treasury bills. The CRA also highlights that Fitch MMF ratings must remain a ranking of funds on the basis of their liquidity, market and credit risk profile.
At end-August 2012 constant net asset value (CNAV) MMFs denominated in euro were generating net yields of 8 basis points (bps) on average, down by 11bps from their early July level, before the ECB rate cut. While fund managers are still able to find short-dated euro assets delivering small positive yields, further potential actions by the ECB to reduce its reference rates would likely push market rates well into negative territory, and euro MMF yields ultimately as well.
The CRA added that there is a limit to the extent fund managers can prevent their funds’ yield from turning negative amid a negative short-term market rate environment, while still maintaining prudent investment strategies. So far, MMF managers have taken a series of measures to maintain their funds’ yields above zero. These include partial fee waivers, which have already been implemented on about half of the euro CNAV funds, and/or selective investment strategy adjustments, after an initial wave of closing funds to new investments.
Fitch notes that most rated MMFs have slightly extended their weighted average life (WAL) over the first three weeks of July, from 43 days to around 50 days on average, while the average allocation to assets with maturities greater than three months increased to 17% from 13%. Since then, WAL has stabilised around these levels. Most of the maturity extension stemmed from a reallocation towards relatively longer-dated assets issued by highly-rated quasi-sovereign entities, corporates and, selectively, some financial institutions. Short-term liquidity has, however, remained stable at high levels with average overnight maturing assets representing 30% of portfolio assets.
Fund managers have now started to prepare for the possibility of negative yields on euro MMFs, reviewing fund structural features accordingly. This notably entails an adjustment of funds’ investment objectives to introduce explicitly the notion of relativity to prevailing short-term market rates. For CNAV funds, the stable NAV and related yield distribution mechanism is being reviewed with a view to limiting operational challenges as well as minimising accounting and fiscal implications for investors, without changing the investment pay-off for investors.
Euro CNAV MMF represented total assets of €106bn at end-August 2012, of which €8bn were in government-only MMFs. Overall, investors in euro CNAV funds have remained relatively stable throughout the summer, although government-only MMFs experienced large investor asset outflows since early July (-26%).
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