The Resilience of MMFs
As interest rates begin to tumble globally, Aviva Investors’ Tony Callcott, Global Head, Liquidity Sales and Distribution and Alastair Sewell, Senior Investment Director, discuss the impact this will have on cash management strategies. They also examine why MMFs remain an attractive option for corporate treasurers.
With major global events as a benchmark, it’s easy to guess someone’s age when you ask them: ‘Where were you when…?’ Similarly, interest rates can place someone in a particular era; maybe they don’t remember the rampant inflation of decades past. They may, however, remember the pain of negative interest rates of only a few years ago.
After a period of relatively high inflation and rates, which followed the global pandemic of 2020, the macro environment is starting a new chapter, one that Callcott says will be “defined by rate cuts rather than rate hikes”. After some initial rate-cutting, inflation appears to be in check, and he expects to see this trend continue over the next six to nine months.
The impact of the rate cuts, however, will differ according to the client type. “In a falling rate environment, corporates are more likely to be looking to increase their debt allocations,” Callcott observes. Because that debt will be cheaper to service, they will typically have higher cash reserves, which will drive a need for them to strategise and allocate that cash effectively for the short term.
Sewell agrees and compares the current period with the rate-cutting of the 2010s. “Some, depending on their age, will remember the pain of the era of ultra-low to negative interest rates.” However, this time round it probably won’t be as extreme. Sewell adds: “We are talking about a falling-rate environment, absolutely, but we’re also talking about falling to a level that is materially higher than it has been in the recent past.”
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Homes for ‘sticky cash’
Given this backdrop, Callcott details how treasurers can adapt and implement strategies that respond to the expected rate changes. “On the corporate side, I think the strategies will remain broadly the same: treasurers will continue to operate their money market funds as they do today.”
He expects the bottom of the rate environment to be around 3% in the UK, which is “still a good rate environment for cash” particularly as the primary reason MMFs are used is for access to liquidity and security of capital.
For clients in the pensions and insurance sectors, the strategies may differ. Callcott points out that they may look to the short-duration products and away from short-term MMFs as they seek a pickup in yield. “Despite this reallocation of cash for some I think the future is still pretty bright for cash MMFs in the short-term space and we’ll continue to see cash reserves increase,” predicts Callcott.
Sewell comments that clients that have a “pocket of cash that is stickier over the longer-term” will benefit from the opportunities in the short-duration space. He adds that this would typically entail a relatively modest allocation to a standard MMF.
This product, Sewell explains, is essentially a regulated MMF, which can take more duration risk and have slightly lower liquidity requirements than a conventional MMF, which is technically known as a short-term MMF.
“We think for some investors, for those with sticky or longer-term cash, they may choose to allocate some of that to these standard MMFs, which should provide a slightly higher yield than short-term MMFs,” Sewell explains. He adds that other investors may look to move out of the short-duration space, but if they choose to do so, they will be moving out of “regulated MMF land” and into a much wider range of products.
Whether investors choose a standard MMF or a short-duration fund, the decision will come down to whether they have longer term cash to allocate, says Sewell. “They can potentially use a combination of these to generate an overall slightly higher, blended, yield going through a rate-falling environment,” he says.
Also, an overall cash management strategy will feature a combination of deposits and MMFs. “They are fundamentally complementary products, and they serve valuable and useful purposes in an overall cash management framework,” explains Sewell. One difference, however, is that bank deposits rates tend to adjust down faster than MMF yields, he notes.
In the context of a rate-falling environment, Callcott is still bullish on MMFs as an attractive option for investors. “MMFs have done what they said they would do, and they’ve got through times of crisis and market stress – they’ve performed well. I don’t see that changing,” he says.
Sewell echoes Callcott’s point: “MMFs are an all-weather product, and they do exactly what they say on the tin, which is to preserve capital, provide liquidity and provide yield. And they do this throughout a range of different market environments”
Different appetites
Sewell elaborates on another instrument: the ultra-short duration bond fund. In what kind of scenario would a company or investor consider this, rather than sticking with the traditional MMF or deposits? Sewell explains a key consideration is how these would be classified. A short-duration bond fund would be classified outside of ‘cash and cash equivalent’, whereas a MMF would not. “That could be a big stumbling block for many investors when considering that kind of investment,” says Sewell.
For those who do have appetite on their balance sheets to add this kind of exposure, there are still a number of factors to consider, explains Sewell, such as the wide range of profiles of fund and their various purposes.
Some funds invest only in the highest- credit quality securities, and there are other funds that enhance yield by adding some lower-quality corporate credit exposure, for example. “The issue with these funds is they’ll have quite different profiles through different market environments, so they can potentially introduce an element of volatility to that investment. This may be unpalatable to some investors, even if it does generate a slightly incrementally high yield,” Sewell explains. “There’s really a fine balancing act to be struck between the work that would be involved in considering these funds and the yield enhancement available.”
Impact of M&A
Another factor that is shaping the current environment is the rise in corporate M&A, as well as an increase in cash balances. Callcott comments that the economic climate is more positive, which is having an impact on corporates’ appetites.
“We’re certainly seeing clients take advantage of the current situation now that confidence is being restored,” confirms Callcott. Some companies are looking to restructure their business, or go through an M&A and, at some point, they will need to raise cash balances in order to do that, he adds.
“We’ve seen some pretty considerable rights issues in the market over the past few months from some of the large FTSE 100 companies,” he continues, which indicates that the timing is right for that type of activity.
He expects more of the same in the coming months. Those companies will be investing in their own infrastructures and creating some pots of cash. That cash needs to go somewhere, such as MMFs and deposits, says Callcott, and investors will want access to the cash and see a better return on their investment – because ultimately it is shareholder money.
A policy fit for purpose
In this environment, where treasurers will want to optimise their cash strategy, Sewell highlights that it is vital to make sure the cash management policy is fit for purpose. “It’s important to make sure that the cash management policy is up to date, it’s effective, and it gives you all the instruments required to manage that cash. Then you must combine that with your ability to forecast and estimate what your cash balances might be over time”, says Sewell.
Callcott dovetails on this point regarding cash forecasting and says it’s important to have a concise picture of cash allocations. Ultimately, he explains, it doesn’t matter what the central bank rate is, what matters is where MMFs fit compared with other products, he notes: “MMFs are a very viable alternative to bank deposits”.
They conclude: “Much as central bank rates are on many treasurers’ minds, the fundamentals of MMFs remain strong in terms of capital stabilitiy, liquidity and the yields they offer; we think they will remain resilient for the foreseeable future.”
