Since 1983, S&P Global Ratings has assigned principal stability fund ratings to money market funds--the well-regarded cash management tool used by institutional investors, with its unique focus on preserving an investor's capital. In our view, the recent market turmoil has one-sidedly shone the spotlight on money market funds, and their potential risk to the wider financial system.

For over 20 years, we have assigned fund ratings to Sterling-denominated money market funds (SMMFs), assessing each under our "Principal Stability Fund Rating Methodology". Each week, pursuant to those criteria, we analyze surveillance data related to all rated money market funds, including credit metrics on asset levels, net asset value (NAV) per share, portfolio credit quality, and duration and redemption patterns.

Overall, we rate these 23 SMMFs 'AAAm'. And recent performance exemplifies the rationale behind the ratings. Before, during, and after the March 2020 market COVID-19 related upheaval, all rated SMMFs, with £247 billion in assets under management, have maintained their portfolio credit metrics. In fact, they have performed exceptionally, demonstrating strong resilience especially compared to their prior record during the 2008 market turmoil around the time of the Lehman Brothers' default. We do see some clouds on the horizon, in particular the potential of negative interest rates but our overall assessment is that the performance of rated SMMFs has been … well, sterling.

The Rise And Rise Of SMMFs

In the late 1990s, rated SMMFs had a total asset base of a mere £2 billion. Since then, SMMFs have prospered. In the past decade, their assets have risen to £247 billion as of May 2020 from £86 billion in 2010 (see chart 1).

Chart 1

Over the past 12 months, overall assets for rated SMMFs have risen 22%. This increase is well above the average 10% annual growth seen in the past decade, despite historically low interest rates (see chart 2). In the past two months (April and May 2020), the appeal of SMMFs has remained strong among investors as they seek to shelter from market upheaval, increasing a healthy 8% and 5.7% each month, respectively (see table 1).

Table 1

Chart 2

The size of rated SMMFs ranges from £23 million to £45 billion, and averages £10.8 billion. The BlackRock Sterling Liquidity Fund, part of the Institutional Cash Series, remains the largest rated fund; it, or variants of it, has been the largest SMMF fund since 2004. It was known as the Barclays Global Investors (BGI) Sterling Liquidity First Fund before BlackRock acquired it in 2009. The top 10 largest SMMFs hold £219 billion (or 88%) of the £247 billion across all rated SMMFs as of May 2020 (see table 2). A primary growth engine for a number of SMMFs is the consolidation within the industry during the past decade. For example:

• Goldman Sachs acquired RBS Asset Management's MMF business in 2013.
• Aberdeen Asset Management acquired Scottish Widows Investment Partnership in 2014.
• Standard Life acquired Ignis Asset Management in 2014.
• Standard Life and Aberdeen Asset Management merged in 2017.

Table 2

NAV Per Share, The Key Measure of Principal Preservation, Is Holding Up Well

The average weekly NAV per share for SMMFs in 2020 has been 1.000086. Comparatively against the low volatility NAV (LVNAV) threshold for MMFs under the EU's money market regulation, the weekly SMMF average is 20.86 basis points (bps) above that threshold, (Regulation (EU) 2017/1131 of the European Parliament and of the Council of 14 June 2017 on Money Market Funds). This implies that the market value of investments has on average been higher than when invested at a par amount of £1.0000 per share, indicating a small capital appreciation to investors on their invested principal.

Despite COVID-19 market pressures, rated SMMFs have preserved their invested capital. From our analysis, during the first five months of 2020, the funds never approached the LVNAV collar of 20 basis points, nor the 'AAAm' threshold of 0.9975, let alone declined due to credit market losses toward 0.9950 per share--the last stop before a money market fund would "break the buck." In the four weeks before and after March 19, 2020, which encompassed pandemic-related market upheavals, the average SMMF NAV per share was £1.00018, or 1.8 basis points above par (see chart 3). Compared with a similar surveillance period around the Lehman Brothers' default in September 2008, NAVs for SMMFs ranged from £0.9987 (13 bps below par) to £1.00014 (1.4 bps above par).

Chart 3

Diligent Credit Research And Stable Underlying Investments

We consider credit quality to play a key role in NAV stability and view higher-rated assets as reflecting higher price stability. In 2008, when a larger number of higher-rated names existed, there was evidence that funds looked to generate yields by investing in lower-credit quality names, so when investments were downgraded, a number of funds found themselves below the PSFR minimum 50% 'A-1+' threshold for 'AAAm' rated MMFs (see chart 4). Nevertheless, on average, the allocation to 'A-1+' names was much higher in 2008 (at 82%) than in 2020, whereas the average allocation to securities rated 'A-1+' has been 71% so far. This year, no SMMF has dropped its issuer credit rating allocation below the 50% 'A-1+' threshold at any point, reflecting the fund manager's diligence to credit research and a relatively stable list of underlying bank and government investments.

Chart 4

SMMFs Keep Weighted Average Maturities Low To Lessen Interest Rate Risk

For a MMF, the maturity of an individual investment and a fund's weighted-average maturity (WAM) are key measures of their sensitivity to changes in interest rates. In general, the longer the WAM, the more susceptible the MMF is to rising interest rates.

Over the past decade, there have been two increases in Bank of England base rates, notably in November 2017 and August 2018, of 0.25% each time. Therefore, when it comes to SMMFs, their susceptibility to "rising" rates has been somewhat muted over that period.

Compared with the four-week period around the Lehman Brothers default in 2008, SMMFs in 2020 have a wider array of short-dated investment choices available to help keep WAMs low (see chart 5), in particular with exposure to overnight reverse repurchase agreements, collateralized by U.K. gilts, which have become more prevalent as an investment tool. These short-dated secured investments along with overnight bank deposits help promote a regular pipeline of liquidity in the portfolio, allowing SMMFs to raise cash as needed. So far in 2020, SMMF WAMs have averaged 40 days, only slightly above the weekly average of 38 days recorded since 2006.

Chart 5

Sudden Redemptions In The Past Haven't Hurt Liquidity

Interest rate sensitivity is not the only factor that can affect the principal value of an MMF's portfolio. Liquidity is also critical to maintaining a stable NAV. Securities that are less liquid are subject to greater price variability; some securities may be liquid one day, yet illiquid the next. When MMFs are open daily to facilitate subscriptions and redemptions, MMF portfolio managers are prepared for unexpected redemptions.

As part of our rating approach, we consider each fund's liquidity needs and ability to sell portfolio holdings to meet cash outflows or large redemptions should the need arise. The liquidity of portfolio investments also affects the fund's market price because a lower degree of liquidity can lead to a lower market value of investments and result in NAV erosion.

The size and breadth of the primary and secondary market, and therefore the demand for different types of securities, factor into the liquidity equation. The greater the demand for an instrument, the more liquid it is; nevertheless, some securities can be quite liquid when the issuer or that market is performing well. When markets turn (due to event risk), some instruments can experience significant price movements and liquidity can dry up rapidly. We saw this happen with structured notes in 1994, funding agreements in 1999, asset backed commercial paper and structured investment vehicles in 2007-2008, and elements of the commercial paper market in 2020.

Our analysis of redemption patterns during these periods indicates that S&P Global Ratings 'AAAm' rated SMMFs have been able to cope. Across three notable periods of increased event risk, (the Lehman Brothers' default in 2008, the U.K. referendum in 2016, and COVID-19 in 2020), we have found that on average, 72% of SMMFs' largest individual weekly redemptions ranged from 5%-10% of assets (see chart 6). Relaying those movements to net assets, on average, 88% of weekly net asset flows ranged from negative 10% to positive 10% (see chart 7).

Chart 6

Chart 7

Table 3

We Expect Relatively Smooth Sailing For SMMFs, But Clouds Could Be On The Horizon

Overall, SMMFs have demonstrated ratings resilience through their credit metrics and demonstrated their preferred status as a cash management tool for institutional investors. Still, a number of factors will continue to shape their appeal such as the uncertainty surrounding the economic recovery from COVID-19, the repercussions of a hard Brexit, and the potential impact to MMFs in the event the Bank of England adopts a negative interest rate policy. For the many types of SMMF investors focusing on capital preservation, negative interest rates will eradicate that prospect. Nevertheless, we believe SMMFs will continue to have a place, as seen with short-term euro-denominated MMFs that are still practical solutions despite their negative yields, for investors who view their cash investments on a relative basis.

Related Research

• European Money Market Funds' Net Assets Held Up In March Despite Market Volatility, Report Says, April 30, 2020
• How Money Market Funds Are A Barometer For Gauging Market Liquidity, April 20, 2020
• So Far, Funds Are Maintaining Stable Net Asset Values Amid Increased Redemptions And Liquidity Pressures, March 25, 2020