Addressing concerns about negative money market yields - Wells Fargo Investment Institute

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Addressing concerns about negative money market yields

Wells Fargo Investment Institute - November 16, 2020

by Todd Noel, CFA, Senior Research Director, Global Manager Research and Brian Rehling, CFA, Head of Global Fixed Income Strategy

Key takeaways

  • The Federal Reserve (Fed) actions taken earlier this year served to enhance liquidity in money market funds. Liquidity remains sufficient at this time, and net asset values generally have been stable and slightly above $1.
  • Money market yields have declined notably this year and are currently at very low levels. While some money markets have reported slightly negative 7-day SEC yields, the actual yields experienced by investors have remained positive.

What it may mean for investors

  • With the Fed’s zero interest rate policy in place, fund yields are very low and we expect them to stay low over the next few years. For investors looking to invest new assets in the money market space, we favor Treasury and government money funds. 

Earlier in the year, the flight to quality during the onset of the coronavirus pandemic had investors keenly focused on liquidity and potential risks in money market funds. The Federal Reserve (Fed) actions taken during that turbulent time in the markets served to enhance liquidity in the broader markets and in money markets more specifically.

A number of things have happened since that time of heightened volatility earlier this year. Importantly, money markets have stabilized and generally returned to more normal operations. Liquidity remains sufficient at this time, with money market funds generally having weekly liquid asset percentages well above required levels, and net asset values generally have been stable and slightly above $1.

Another notable development has been the downward trend in yields. With the Fed instituting a zero interest rate policy earlier in the year, money market fund yields trended consistently lower over the course of the year and are currently at very low levels. It is primarily due to these very low yield levels that investors are wondering about the possibility of yields turning negative.

The true investor yield experience in money market funds

We already noted that money market yields are very low, but have investors actually experienced negative yields in the recent low-yielding environment? The answer to that question has been clouded by some money funds reporting slightly negative yields recently. The primary yield metric for which investors have observed a slightly negative yield reported is the 7-day SEC yield. The 7-day SEC yield is the primary yield metric that managers report externally. The problem with this yield metric is that it does not account for any distributions made by the fund or for certain fixed expenses that the manager may voluntarily waive. Consequently, the SEC yield is not a good representation of the yield that investors actually receive.

The more specific answer to the question of whether investors have experienced negative yields in money funds is no, investors have not experienced negative yields in the recent low-yielding environment. There are several important proof points to support this:

  • 1-day yields of money funds have been consistently positive. These 1-day yield figures incorporate distributions and any fixed expense waivers.
  • A review of the yield actually distributed to investors over any 1-day, 7-day, or other period shows yields have been positive. Managers use various names for this yield metric, but it is essentially the “distribution yield,” or the yield actually experienced by investors, which is different from the SEC yield.
  • Managers are committed to maintaining positive money market yields. Many managers currently are waiving a portion of their management fee to ensure they maintain positive yields.
  • There are currently no operational means for money market funds to account for negative yields. In our view, this just solidifies the fact that investors are not actually experiencing negative yields.

The industry is currently exploring ways that fund companies could account for negative yields in money funds if they actually turn negative in the future. However, the only potential scenario where we see the need to account for negative yields in money market funds is if the Fed implements a negative interest rate policy. On this topic, the Fed has made it known numerous times that it has no intention of pursuing a policy of negative rates.

What it may mean for investors

With the Fed’s current zero interest rate policy, it is not surprising to see very low yields in money market funds. We suggest investors reference 1-day yields or “distribution yields” to understand the yields they are actually experiencing in their money funds. It is also important to understand that with the Fed’s zero interest rate policy guidance, we expect fund yields to stay low over the next few years.

For investors seeking to put new money to work in the money market space, we suggest consideration of Treasury and government money market funds. While the yields on Treasury and government funds are currently very similar, we would give a slight nod to government funds because they hold a variety of government instruments beyond just Treasuries, which provides diversification and additional potential sources of yield.

While we do not have significant concerns with prime money market funds, the small yield advantage they currently hold over Treasury and government money funds makes it tough to justify taking the incremental risk that is associated with prime funds. One data point we are watching closely with prime funds is outflows. As a result of the current small yield differential with other types of money funds, prime funds have experienced some outflows, which is something we will continue to monitor.

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