News & analysis


INVESTORS PARK THEIR CASH IN MONEY MARKETS AS OPTIMISM IS PUT ON HOLD


Following dramatic outflows in the first quarter, the European fund industry is now recording cautious optimism, but inves- tors are overwhelmingly choosing to park their money in liq- uid 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 invest- ment funds, the sharpest drop in flows since the 2008 global financial crisis, according to Lipper, a data provider. Combined with the impact of an overall drop in asset prices, assets managed by the European fund industry fell to €10.6trn (£9.5trn) from €12.3trn (£11trn) at the beginning of the 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 says, a move that reflects a contin- ued demand for liquidity. This is also evident in the monthly asset allocation survey pro- duced by Dutch data firm Alpha Research. More than 40% of surveyed respondents are overweight on cash, while close to 40% are still underweight on equities.


The money market fund sector has grown exponentially to


€680bn (£612bn), compared to the €40bn (£36bn) it was worth at the start of the century. By the end of 2018, more than 40%, or €267.2bn (£240.8bn), was held by UK institutional investors, according to data pub- lished 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 of 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 was large corporate in- stitutions 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 (CDs) and were faced with the decision of potentially having to gate access to investors, a situ- ation which could have been potentially disastrous for institu- tional investors, Hauser recounts. While an escalation of the crisis has been averted by central bank around the world injecting huge sums of cash into their economies, Hauser warns that it is far too early to “take the lap of honor” and that money market funds could play a key role in accelerating the dash for cash in the event of another market crash.


DB DEFICIT SURGES IN Q1 WHILE SPONSORS PUT CONTRIBUTIONS ON HOLD


Covid-19 has hit pension scheme balance sheets hard, largely due to a spike in s179 liabilities as a result of lower gilt yields, a problem which could be aggravated by a drop in deficit contributions.


The aggregate deficit of the more than 5,000 schemes in the Pension Protection Fund (PPF) universe rose to £176.3bn by the end of May.


This is a huge increase on the £35.4bn that the final salary scheme black hole stood at on the final day of 2019. The deterioration in a scheme’s funding position is largely driven by a fall in gilt yields, rather than a decline in asset pric- es, as the value of assets increased marginally on a year-to-date basis to £1.9trn from £1.6trn, PPF data shows. Over the past year, yields on 10-year gilts have fallen by -75 ba- sis points and 20-year gilt yields dropped by -85 basis points, a


8 | portfolio institutional July 2020 | issue 94


trend which is digging an accounting blackhole in many de- fined benefit (DB) schemes’ purses. Viewed over the course of the past 10 years, the spikes appear much less dramatic, as deficits have fallen to much lower lev- els in 2012, 2014 and 2016. However, the recent funding shortfall could be aggravated by up to one fifth of UK scheme sponsors are currently consider- ing suspending their deficit repair contributions (DRC). Ac- cording to a recent survey of 380 trustees and corporate clients by ISIO, 12% of sponsors had already requested a DRC. Half of these requests have so far been accepted by trustees. ISIO esti- mates that if all DRC requests were to be accepted, it would re- sult in £200m deficit reductions going unpaid each month. As DB schemes are maturing, DRCs account for a growing share of sponsor expenses.


In Q4 2019, they accounted for 60% of all employer payments into DB and hybrid schemes according to the latest ONS Occu- pational Pensions Survey.


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