As we mentioned late last week in our May Money Fund Intelligence, the Investment Company Institute released its "2020 Investment Company Fact Book," an annual compilation of statistics and commentary on the mutual fund industry. Subtitled, "A Review of Trends and Activities in the Investment Company Industry," the latest edition reports that equity funds slowed, bond fund inflows jumped, and money market funds had their strongest inflows in almost 10 years in 2019 ($553 billion). Overall, money funds assets were $3.632 trillion at year-end 2019, making up 17% of the $21.3 trillion in overall mutual fund assets. Retail investors held $1.370 trillion, while institutional investors held $2.262 trillion. We excerpt from the latest "Fact Book" below.

ICI writes, "Worldwide net sales of money market funds in 2019 totaled $706 billion, which was nine times the $79 billion inflow in 2018....The sharp increase was largely driven by money market funds in the United States, where inflows were more than three times as great, from $182 billion in 2018 to $586 billion in 2019. In Europe, money market funds experienced inflows of $70 billion in 2019 after outflows of $22 billion in 2018, and Asia-Pacific money market funds registered $30 billion in inflows in 2019 after outflows of $99 billion in 2018."

They explain, "Demand for money market funds depends on their relative performance and interest rate risk. When yields on short-term fixed-income securities are close to yields on long-term fixed-income securities, money market funds tend to experience inflows. In this situation, money market funds become attractive to some investors seeking to minimize their interest rate risk exposure by using a fund with a shorter duration."

The Fact Book continues, "As the US Treasury yield curve flattened and even inverted for a short period in 2019, investors exhibited a strong demand for US money market funds and short-term bond funds. Similarly, European money market funds experienced inflows as yield curves flattened in Europe during 2019. Finally, as yield spreads throughout the Asia-Pacific region narrowed or turned negative, money market funds in various countries in the region also started to experience inflows during 2019."

ICI tells us, "Businesses and other institutional investors also rely on funds. For instance, institutions can use money market funds to manage some of their cash and other short-term assets. At year-end 2019, nonfinancial businesses held $691 billion (18 percent) of their short-term assets in money market funds." (This is unchanged from 18 percent in 2018 but down from 22 percent in 2013 and down from the peak of 40 percent in 2008.)

They comment, "Historically, mutual funds had been one of the largest investors in the US commercial paper market -- an important source of short-term funding for major corporations around the world. Mutual funds' demand for commercial paper arose primarily from prime money market funds. But the 2014 SEC rule amendments required the money market fund industry to make substantial changes by October 2016. Consequently, prime money market funds sharply reduced their holdings of commercial paper -- by year-end 2016, the share of the commercial paper market held by mutual funds was 19 percent, down from 46 percent at year-end 2014. By year-end 2017, the share of the commercial paper market held by mutual funds increased to 25 percent and from then on remained largely unchanged through year-end 2019."

In a short section on "Money Market Funds," the Fact Book states, "In 2019, money market funds received $553 billion in net new cash flows.... up from $159 billion in 2018. Government money market funds received the bulk of the inflows ($364 billion), followed by prime money market funds with $198 billion in inflows. Tax-exempt money market funds, on the other hand, had net outflows of $9 billion in 2019."

It adds, "The increased demand for money market funds likely stems from the relatively attractive yields on short-term assets in 2019. The Treasury yield spread -- measured as the difference in yield between 10-year Treasuries and 3-month Treasuries -- started 2019 at a narrow 24 basis points. By late August, as market participants became more pessimistic about a resolution in trade tensions between the United States and China and its negative implications for US economic growth, the Treasury yield spread was hovering around a negative 50 basis points -- meaning that 3-month Treasuries were returning more income to investors than 10-year Treasuries."

Finally, they write, "Over the remainder of 2019, actions taken by the Federal Reserve to lower the federal funds target rate pushed short-term interest rates down, while more optimism about the future state of the economy helped to push long-term interest rates up. The Treasury yield spread finished the year at 37 basis points. Even with the reduction in the federal funds rate in 2019, yields on prime and government money market funds remained attractive and far exceeded the stated rate on money market deposit accounts (MMDAs)."

In other news, the Bank for International Settlements published a new "BIS Bulletin," entitled, "US dollar funding markets during the Covid-19 crisis - the money market fund turmoil." Its "Key takeaways" include: "Short-term dollar funding markets experienced severe dislocations in mid-March 2020, with funding diverted from unsecured funding markets as investors withdrew and switched to secured funding markets and government MMFs. Outflows from US prime MMFs led to a loss of funding for banks and a significant shortening of funding maturities; this precipitated spikes in indicators of bank funding costs, such as the LIBOR-OIS spread, despite banks not being at the epicentre of the liquidity squeeze. The turmoil highlights broader lessons for MMF regulation, the role of non-banks for monetary policy implementation, and the role of the central bank during stress."

Authors Egemen Eren, Andreas Schrimpf and Vladyslav Sushko write, "The Covid-19 crisis severely disrupted the functioning of short-term US dollar funding markets, in particular the commercial paper and certificate of deposit segments. Commercial paper (CP) is a form of short-term unsecured debt commonly issued by banks and non-financial corporations and primarily held by prime money market funds (MMFs). Certificates of deposit (CDs) are unsecured debt instruments issued by banks and largely held by non-bank investors, including prime MMFs. Both instruments are important sources of US dollar funding for banks, especially for non-US headquartered banks."

They continue, "The tensions lingered until end-April and spilled over to other international money market segments. Notably, they were the main factor behind the widening of LIBOR-OIS spreads to levels second only to those last seen during the Great Financial Crisis (GFC), and contributed to wide swings in offshore dollar funding costs. As such, they hampered the transmission of the Federal Reserve's rate cuts and other facilities aimed at providing stimulus to the economy in the face of the shock. This Bulletin analyses strains in MMFs exacerbating the stress in US dollar short-term funding during the Covid-19 crisis. The companion bulletin (Eren, Schrimpf and Sushko (2020)) focuses on the US dollar funding stress for non-US banks in particular and how the disruptions to CP/CD markets reverberated globally via FX swap markets." (See also BIS's "US dollar funding markets during the Covid-19 crisis - the international dimension.")

Lastly, the study explains, "Amid escalating market turmoil, market participants wanted to hold cash or something that resembles cash as closely as possible. At the same time, financial intermediaries experienced difficulty accommodating the surge in demand for safe and liquid assets. MMFs, in particular, were strained by this 'dash for cash.' Prime MMFs had to liquidate large parts of their portfolios, while government MMFs had to buy more assets to accommodate surging inflows, all in a very short order. Even though, unlike the GFC, banks were not at the epicentre of the crisis, dealers were unable or unwilling to expand their balance sheets sufficiently to intermediate all the rebalancing taking place in money markets. The Federal Reserve's intervention managed to restore market functioning."

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