Investing October 27, 2016

Prime Money Market Funds Making Changes to Woo Back Investors

There has been a shift to investing in government money market funds since the SEC’s new money market fund reform.
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Prime money fund managers have begun to revert back to more normal portfolio management strategies following money fund reform implementation, as outflows from prime funds have stabilized, according to the latest Fitch Ratings Money Fund Reform Dashboard.

“Managers have been extending maturities and reducing liquidity in a bid to increase prime funds’ yields and lure investors back from government money funds,” says Greg Fayvilevich, senior director, Fitch Ratings.

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The mass exodus from prime institutional money market funds slowed down in the week following the implementation of money market fund reforms on October 14, with $3 billion leaving prime funds. This is a relatively modest amount considering that since October 27, 2015, these funds lost approximately $861 billion in assets, primarily to government money funds. The significant shift away from prime institutional funds was largely driven by investor discomfort with the funds’ new features—liquidity fees and redemption gates, as well as a floating net asset values (NAV).

Post-reform, fund managers have been reducing historically high levels of liquidity, although liquidity continues to be elevated. Average weekly liquidity across 28 prime institutional funds reviewed by Fitch fell 7% from a peak of 87% on October 7, 2016, to 80% on October 21, 2016. On average managers continue to maintain significant liquidity buffers above the 30% threshold to avoid the possibility of triggering liquidity fees or redemption gates.

With managers now investing further out the curve, the yield spread between institutional prime and government funds has increased, reaching 0.18% as of October 21, 2016.

“The spread is likely to continue to widen as managers and investors get used to the new environment and portfolios further normalize. Yield differentials may gradually lure investors out of government money funds back into prime funds, or into alternative liquidity products such as short-term bond funds and private funds,” says Fayvilevich.

The report, “U.S. Money Fund Reform Dashboard”, is available at https://www.fitchratings.com/site/re/889672. A login is required.

Investing October 26, 2016

DC Plan Sponsors Curious About Strategic Beta

Cerulli pegs interest in “smart beta” to a heightened focus on fees that has proven to be a boon for passive managers while simultaneously creating a significant headwind for their active counterparts.

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Fee pressure is the dominant theme within the defined contribution industry, suggesting active investment managers may begin to focus more on smart-beta indexing over their traditionally preferred approaches to remain competitive.

This is according to the latest issue of The Cerulli Edge – U.S. Monthly Product Trends Edition, which concludes that DC plan advisers and sponsors are increasingly considering strategic beta as an alternative to traditional active management. Cerulli pegs the trend to a heightened focus on fees that has proven to be a boon for passive managers while simultaneously creating a significant headwind for their active counterparts.

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Cerulli data illustrates corporate defined contribution (DC) asset owners are adopting use of “strategic” or “smart” beta, with asset managers reporting that, on average, 11% of such products are available for corporate DC plans.

“The majority of product development has occurred within the ETF wrapper, a vehicle not as conducive to the DC space, especially within 401(k) plans,” Cerulli observes. “Asset managers that have strategic beta or are in the midst of developing strategic beta should not overlook the DC market as an area of opportunity to grow assets.”

To clarify an important definition, Cerulli notes that the catch-all terms “smart beta” or “strategic beta” simply refer to rules-based styles of strategic indexing that go beyond the traditional factors of market capitalization, momentum or value to build portfolios that seek to deliver market outperformance and better risk-adjusted returns. Unlike the “alpha” outperformance sought by tactical active managers, the outperformance of smart beta is supposed to come from the design of the index and pre-programmed trading rules.   

According to managers interviewed by Cerulli, concerns about lack of diversification of their market-cap-weighted passive strategies has institutional investors (including pensions and DC plans) thinking more about implementing strategic beta in their portfolios.

“The high cost of active strategies is also driving more institutions to strategic beta,” Cerulli says. “Many institutional investors have a collection of active managers with a neutral or conflicting set of exposures at the plan level. Adding strategic beta through a satellite position allows institutions to tilt plans toward a desired exposure.”

NEXT: Important facts about the smart beta market

The Cerulli analysis goes on to suggest the impending Department of Labor (DOL) fiduciary rule may also accelerate the adoption of strategic beta on DC plan investment menus.

“In order to offer strategies that are in the best interest of their participants, DC sponsors may find themselves converging toward a middle ground,” the report explains. “Strategic beta can be an alternative choice to ensure DC sponsors are offering a product that can potentially provide alpha as well as protect against risk on the downside for a slightly higher fee than passive, but a lower cost than active.”

According to Cerulli, depending on the complexity of the strategy, strategic beta can cost on average anywhere between 25 bps and 50 bps.

“Exceptions to this include custom strategic beta where managers are charging upward of 50+ bps,” Cerulli warns.

The research firm “believes that in order to offer a robust product lineup that will satisfy the needs of best interest fiduciary standards to participants, sponsors should consider placing strategic beta into their menu offerings … In order for strategic beta adoption to succeed in DC plans, asset managers also need to ensure they educate plans sponsors about the methodology of strategies and the suitability of strategies in conjunction with their overall plan menu.”

Citing additional data from an FTSE Russell survey, Cerulli says more than one-third (36%) of investors prefer strategic beta products to be packaged as separate accounts. An additional 26% are interested in managing these products internally.

“The rest of asset owners polled prefer ETFs (11%), collective investment trusts (CITs) (14%), mutual funds (10%), and derivatives (3%),” Cerulli concludes.

More information on obtaining Cerulli Associates research is available online here. 

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