Following research from Calastone on equity funds suffering further with outflows as investors turn to cash, David Roberts – Head of Fixed Income at Nedgroup Investments comments on money market funds taking £364m, their strongest inflow since November.
Money market fund assets in the US alone are estimated to be running at close to $8 trillion, a figure that has grown steadily as savers and institutions have taken advantage of the highest cash rates seen in a generation.
It is easy to understand the appeal. After more than a decade in which cash paid next to nothing, being able to earn a healthy, low-risk yield simply by holding money market instruments has felt like a genuinely attractive option, requiring no real thought about duration, credit risk or market timing.
Money market funds are, by design, extremely responsive to short-term interest rates. When central banks cut rates, money market yields fall in step, usually within one or two rate decisions.
Bond yields, on the other hand, tend to move in anticipation of rate cuts rather than in response to them, because markets are constantly pricing in the future path of policy rather than simply reacting to what has already happened.
This creates an important, and often under-appreciated, sequencing issue for cash-heavy investors. The most attractive point to reallocate out of money market funds and into longer-duration fixed income is typically before the first-rate cut arrives, while bond yields are still elevated and cash is still paying an attractive rate.
Once the first or second cut has actually landed, money market yields begin to fall visibly, and it becomes apparent, in hindsight, that the opportunity to lock in higher yields further out the curve has already started to close.
In practice, most investors do the opposite. They wait for clear, unambiguous evidence that a slowdown is under way and that a series of rate cuts is coming, by which point a meaningful part of the potential capital gain in bond markets has often already occurred.
This is a natural, understandable behaviour. Nobody wants to reallocate out of a comfortable, high-yielding cash position on a hunch. But it means that the eventual rotation out of money market funds tends to happen later, and capture less value, than the mechanics of the cycle would ideally allow.
Main image: magnifying glass, analyse, research, markus-winkler-afW1hht0NSs-unsplash
