Tax-exempt money market funds have recently showed renewed strength after several years of lackluster yields in a prolonged low-interest-rate environment. For treasury and financial risk management professionals, this presents an attractive opportunity to earn interest on corporate investments, with the potential for even more yield as rates increase later this year.
A weekly high-grade market index composed of seven-day tax-exempt variable-rate demand notes (VRDNs), known as the SIFMA index, has increased steadily from yields of 0.01 percent at the beginning of 2016 to as high as 0.87 percent on October 3, 2016. The average from August 2016 to January 2017 for the SIMFA index was 0.66 percent yield, which compares very favorably with a 0.05 percent average for 2015.
Meanwhile, yields of one-year municipal notes have risen from 0.62 percent at the start of 2016 to the current 0.95 percent yield posted by Bloomberg Valuation on February 14, 2017. At these levels, the SIMFA is providing 92 percent of the yield reflected by the LIBOR seven-day average, according to Muni Monitor Analytics.
Highly liquid, high-quality municipal money market instruments provide even more robust real returns when their tax advantages are considered, although obviously their relative attractiveness varies depending on the investor’s tax bracket. Investors should keep an eye on the municipal money market yields, as we expect them to remain attractive compared with taxable money funds with comparable maturities and similar credit ratings.
Demand for VRDNs fell substantially as municipal money market fund (MMF) assets decreased ahead of last October’s money market reforms. Yet the supply of floating-rate tax-exempt instruments has remained relatively steady. In fact, the volume of outstanding VRDNs currently exceeds total assets under management by municipal money market funds, which we believe makes municipal VRDNs a very strong investment right now.
The imbalance between strong supply and weak demand has put upward pressure on current yields of floating-rate instruments. This segment of the market should remain attractive to non-traditional buyers, such as corporate treasury teams.
Furthermore, fiscal conditions generally remain favorable for tax-exempt issuers, and municipal credit quality appears to have stabilized after years of gradual improvement since the depths of the 2008 recession. This is particularly evident at the state government level, where replenished rainy-day emergency funds provide a cushion against future economic downturns. In addition, tax receipts for most states have surpassed pre-recession levels, enabling state governments to balance their operating budgets or achieve budget surpluses.
Now is a good time for investors to reconsider the attractiveness of municipal MMFs relative to government funds. The once-debated spread that was challenged by money market reforms has returned with the stabilization of this asset class (see Figure 1, at right). We expect assets to begin flowing back into this space as investors, both retail and institutional, see the appeal of a tax-exempt product that is very transparent and highly liquid.
In this environment, municipal money market funds have an important role to play in the portfolios of corporations and institutional investors. Now that the uncertainty surrounding money market reform has passed, these products’ attractive yields should increase demand. As the Federal Reserve raises interest rates, we see these funds as well-positioned to take advantage of this increase. And from an investment standpoint, there is no better time to capitalize on their yields.
For those seeking higher returns on their cash, high-quality, highly liquid municipal money market funds are worth a closer look.
Colleen Meehan is a senior vice president and director of municipal money market fund strategies for BNY Mellon Cash Investment Strategies (“CIS”), a division of The Dreyfus Corporation. She is responsible for the management of Dreyfus’ national and state-specific tax-free money market portfolios. Meehan is an active member and sits on the boards of the Municipal Bond Women’s Club of New York and the Municipal Bond Club of New York.
Views expressed are those of the author and do not reflect views of other individuals or the firm overall. Views are current as of the date of this communication and subject to change. This material has been distributed for informational purposes only and should not be construed as investment advice or a recommendation for any particular investment. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission.
Variable rate demand notes are subject to the borrower's ability to pay interest and principal on a timely basis, market price fluctuation if sold prior to maturity, and the potential lack of marketability which may limit the ability to sell the VRDN quickly enough to prevent or minimize loss.
The Dreyfus Corporation and MBSC Securities Corporation are wholly owned subsidiaries of The Bank of New York Mellon Corporation.