Money market funds losing safe haven allure

Money market funds may be losing their safe-haven status as worries about banking sector exposures compound near-zero interest rate returns, leading to a third year of capital outflows. Shocks this year including Arab world unrest and Japan's earthquake, and simmering fears of a Greek default and ebbing economic momentum, have not halted the exodus from money funds, which have seen outflows of some $130 billion so far in 2011.
According to data monitor EPFR, total outflows from money funds are a whopping $1.1 trillion since the credit crisis peaked in early 2009, far outweighing the inflows into these funds seen as the banking crisis unfolded in 2007-2008.
While a cyclical reversal of those crisis-driven flows would be easily explained in a global economy still growing in excess of 4 percent a year, the continued haemorrhaging from these funds to below pre-crunch levels suggests more is at play.
On top of the hit from zero interest rate policies in the major economies, money funds have been undermined by their exposure to European banks and the potential damage to their asset value should Greece default on its sovereign debt. "Money market funds and cash returns are so low and the opportunity cost for holding cash is too high," said Ted Scott, director of global strategy at F&C Investments.
"The direct exposure of European banks to Greek debt has a wider ramification and the secondary effect of Greece going bust is a reason to be concerned."
Concerns about an immediate Greek default have dissipated somewhat after the country secured the latest tranche of its international rescue loans. But this week's credit rating downgrade of Portugal to junk status has rekindled worries about eurozone government debt and banking sector exposure to it.
Money funds have been traditionally regarded as an alternative to bank deposits as they aim to maintain a stable share price, typically $1 per share, and prioritise giving your money back with slightly higher returns than a savings account.
Faith in this money fund promise was undermined at the height of the financial crisis, when top US money manager Reserve Primary Fund "broke the buck", its net asset value per share falling below $1 in September 2008. The sector's perceived safe-haven status has never fully recovered.
Similarly in Europe, Standard Life suffered a loss on one of its money market funds in 2009 by investing in asset-backed securities linked to the mortgage market. These concerns resurfaced as investors grew nervous about the exposure of money market funds, especially in the United States, to European banks.
Keen to enhance returns in the low-yielding climate, US money market funds have bought $600 billion of European commercial paper and certificates of deposit - 3.5 percent of total liabilities - a third of which is issued by French banks, according to J. P Morgan.
Fitch estimates US money market funds' exposure to European banks to be roughly 50 percent of their total assets. "Money market funds are a potential channel for eurozone credit market volatility. For European banks, a loss or reduction in money market funds funding could create negative perceptions about an institution's financial strength," the credit rating agency said in a report.
It also noted that money funds are facing a conundrum as efforts by bank regulators to reduce reliance on short-term funding - a major problem during the crisis - create a tension with securities regulators who aim to reduce the maturity profile of money funds' investment.
This is resulting in a decline in the overall size of the industry, risking a lack of liquidity that could become another reason to drive investors away.
Money funds based in Europe are also struggling. Data from Lipper shows demand for European-domiciled money market funds in sterling, dollar and euro have plunged since 2009, with the euro class alone shedding 19 billion euros of assets in the first four months of 2011.