Funds flow out of money markets

By Michael Mackenzie in New York Published: June 24 2009 19:02 Last updated: June 24 2009 19:02 During the worst days of the credit crisis last year nervous investors piled into US money market funds in a desperate search for safety. The amount of money parked in these funds reached a peak in the early months of this year. But since March, as risk appetite has increased once again, billions of dollars have been flowing out of the funds – one of the main reasons for the revival of some asset classes in the last few months. Emerging market equities and bond funds have been winning investment flows at the expense of money funds and developed equity markets, according to EPFR Global, which tracks fund flows and asset allocation data. “Cash continues moving off the sidelines in search of higher returns and a degree of protection against anticipated dollar weakness,” says Cameron Brandt, senior analyst at EPFR. Money market assets totalled $3,903bn for the week ending March 11, and since then have steadily dropped. Meanwhile, long- term mutual fund equity inflows resumed during April and have remained positive for domestic and foreign markets according to Investment Company Institute data. Flows into bonds have been positive every month this year and have exceeded equity inflows by a significant margin. “The decline in money market fund assets since March has been a good sign of improving risk appetite,” says Gerald Lucas, senior investment advisor at Deutsche Bank. “It is one of the barometers to watch.” The total net assets of all US money market funds was $3,674bn for the week ending June 17, down from the prior week’s total of $3,747bn according to ICI data. That figure compares with the current market capitalisation of $7,800bn for the S&P 500. Some of the recent drop in money market fund assets is explained by companies and individuals paying their taxes in June. Last June for example, assets dropped from $3,540bn to $3,477bn. The current numbers show that while some $250bn has flowed out of US money funds since the peak earlier this year, the overall preference for safety and earning next to zero yields remains historically high. “Although the wall of cash has sprung a few leaks, there is still a substantial sum sitting in money market funds,” says Peter Crane, publisher of Money Fund Intelligence. This partly reflects the evaporation of short-term investment opportunities. The once popular auction rate securities market and structured money fund plans which invested in asset-backed paper have fallen out of favour since the credit crunch began. As people need to park funds in liquid instruments, this helps explain the current substantial level of money market assets. Until the bankruptcy of Lehman Brothers last September, money market funds were seen as safe cash-like holdings. That view changed when the Reserve Fund saw its assets fall below par, or what is known in the industry as “breaking the buck” and investors lost money. Investors thus pulled money out of funds that invested in riskier assets and raced into safer funds, which focused on Treasuries. By the start of the year, money market assets surged to an all-time high of $3,919bn, up from $3,159bn at the start of 2008. However, with the Federal Reserve embracing a zero interest rate policy, returns from money funds have dropped, forcing some managers to cut fees in order to stop their funds from “breaking the buck”. “It is clear that some investors are looking at higher yields and returns elsewhere,” says Mr Crane. Much of the flows into bonds in recent months has targeted municipal or local government securities, whose yields surged above Treasuries last year, a significant dislocation given that munis provide some investors with a tax-free return. Since the start of April, some $16bn has flowed into tax-exempt municipal mutual funds, according to ICI. Thanks to this buying, muni bond prices have risen, with yields returning to more normal levels versus US Treasuries. “A lot of money has gone into municipals, less so into equities,” says Jim Paulsen, chief investment strategist at Wells Capital Management. The pace of flows out of money funds into equities could slow in the coming months as investors remain unsure about the “green shoots” of an economic recovery later this year. “The equity market is waiting to see where the global economy is going,” says Mr Lucas. The March rally for equity markets in the US, UK and Europe has faltered in recent weeks and key benchmarks have been trading around important support levels. For equity bulls, the wall of money on the sidelines is a crucial missing ingredient for the stock market. Mr Ablin says: “These liquidity levels are a harbinger of bullish developments in stocks for the next couple of years.” While Mr Paulsen concedes “the money mountain has not been dented that much”, he says this mood will eventually change. “This environment reminds me a lot of what we experienced in 1982, when stocks rose 40 per cent from their lows and paused for several months,” he said. “It was not until 1983, that people bought into the recovery.”