Amid dramatic outflows in the first quarter, investors overwhelmingly choose to park their cash in liquid vehicles such as money market funds, a move that puts the risk of another liquidity crunch firmly on the horizon.
With stock markets plunging in March, European investors withdrew €125.9bn (£113.4bn) in assets from European investment funds, the sharpest drop in flows since the 2008 global financial crisis, according to Lipper Data. Combined with the impact of overall drop in asset prices, assets managed by the European fund industry fell by to €10.6trn (£9.55trn), compared to €12.3trn (£11.09trn) at the beginning of this year.
Fuelled by unprecedented levels of central bank intervention, markets are gradually returning to normal, but asset allocation trends highlight that caution prevails. Throughout May, the European fund industry reported net inflows of €96.1bn (£86.6bn), but the overwhelming majority of these assets went into bond (€29.6bn / £26.68bn) – and money-market funds (€22.7bn/ £20.4bn), Lipper data shows, reflecting a continued demand for liquidity.
This is also evident in the monthly asset allocation survey produced by Dutch research firm Alpha Research. More than 40% of survey respondents are overweight on cash, while close to 40% are still underweight on equities.
The money market fund sector has grown exponentially since the early 2000’s, to €680bn (£612bn), compared to €40bn (£36bn) 20 years ago. By the end of 2018, more than 40%, €267.2bn (£240.8bn), was held by UK institutional investors, according to data by the Institutional Money Market Funds Association. But precisely because of the ease of withdrawing cash, money market funds were subject to an acute liquidity crunch as the crisis hit.
A speech by Andrew Hauser, executive director Markets at the Bank of England, revealed that in the week between 12 and 20 March, money market funds booked £25bn in outflows, some 10% of their total assets. A key driver behind this dash for cash were large corporate institutions drawing down their credit facilities as income streams came to a sudden hold.
Money market funds attempted to meet this dash for cash by initially running down their own cash reserves but this turned out to be insufficient. Money market funds soon found out that they were unable to liquidate certificates of deposit (CD’s) and were faced with the decision of potentially having to gate access to investors, a situation which could have been potentially disastrous for institutional investors, Hauser recounts.
While an escalation of the crisis has been averted by a combination of international central bank efforts, Hauser warns that it is far too early to “take the lap of honour” and that money market funds could play a key role in accelerating the dash for cash in the event of another market crash.