Post-Brexit, All Eyes Are On PrExit

Post-Brexit, all eyes — at least those in the money fund world — are on the potential mass exit of cash from prime funds to comply with the new money fund rules. Citi has coined the term "PrExit" to term the exit of cash from prime funds.

Citi said, "Money fund managers await the compliance date of October 2016 with much trepidation," and "some are expecting outflows to the tune of hundreds of billions of dollars."

What's Going On?

Beginning October 14, 2016, institutional prime funds will be subject to floating NAV and gates and fees. Furthermore, retail prime funds could also find themselves subject to gates and fees. At this point, MMF managers have already announced conversions from prime funds to government funds "for assets affecting about $300 billion."

Citi explained, "The majority of these conversions affect retail prime funds (about $189 billion since December 1, 2015), and institutional prime funds make up a much smaller number (only about $55 billion since December 1, 2015). Excluding conversions, the actual outflows from institutional prime funds are about $207 billion while retail prime funds have actually witnessed about $25 billion in inflows."

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"In our view, the total outflows across both retail and institutional prime funds are likely to be around $100 billion, although there is a chance that it could be as high as $200 billion," analyst Vikram Rai wrote in a note.

Citi believes that actual outflows from prime funds will be smaller than general expectations.

Reallocation Options?

"Market participants have speculated that eligible investors could reallocate out of institutional prime funds into ultra-short or short duration funds, which offer higher yields," Citi stated.

"In our view, the majority of money fund investors, who look to liquidity and return of principal before the return on investment, are unlikely to transition to ultrashort duration funds," Rai noted.

However, for those individuals positioned to burden themselves with "the added risk of short-term bonds," Citi stated that they "continue to allocate a portion of their portfolios to this asset class in lieu of money funds."

"In the current environment, where the market expects rate hikes over the next 12–18 months, investors who are primarily concerned with capital preservation may determine that 1YR–2YR fixed-rates do not offer adequate compensation for expected rate hikes as well as increased risk and volatility."

"While we could see some investors move toward the shorter end of the curve (1–2YR sector), it will likely be in order to reduce duration risk in a rising-rate environment. Thus, these assets will come out of longer duration funds," Rai highlighted.

The analyst concluded, "Thus, despite the advent of short and ultra-short duration funds, we do not believe that these will cannibalize money funds assets materially." Currently, Rai expects money fund assets to end 2016 somewhat flat as compared to 2015.