Local government investment pools extended maturities in recent weeks, anticipating the shift in Federal Reserve monetary policy that reduced the pace of tightening after the sharp run-up in interest rates over the past 18 months. Pool portfolios moved from very short weighted average maturities (WAMs) in the spring and are now positioned for limited moves higher in interest rates in the near term. Meanwhile pool yields have risen to fully reflect current market conditions.
These are conclusions from a review of portfolio characteristics reported by S&P Global. The rating agency tracks and reports key investment metrics for the stable net asset pools that it rates—currently 66 pools with about $325 billion of assets.
The S&P LGIP General Purpose/Taxable Index (these funds are like prime money market funds) reported a net yield of 5.38% for the week ending September 1. The net yield for the LGIP Index Government index was 5.25%. These yields are higher by 28 basis points and 26 basis points respectively from the week ending June 2.
The following table summarizes LGIP net yields and WAMS:
The Federal Open Market Committee met three times in this period, raising rates by 25 basis points at its late July meeting, but making no change at its June and just-concluded September meetings. The slower pace of tightening followed 10 straight quarter point increases in the Fed’s reference rater beginning in March 2022.
Funds tracked by S&P maintained short WAMs while the Fed tightened, with the low point in maturities in the spring. They lengthened weighted average maturities modestly in June, July, and August, anticipating that the Fed would soon slow, or perhaps end, its pace of rapid monetary policy tightening.
By this month, weighted average maturities had been extended modestly to 35 days for prime-type funds and 25 days for government funds. These levels are near the mid-point of the range that is required—with a 60-day maximum WAM-- to maintain an S&P’s top rating.
Money market fund managers for Rule 2(a)-7 government and prime funds made similar WAM extensions between June and August, and these funds also are now positioned in a more neutral posture regarding rate movements in the next 90 days.
The FOMC action and statement after the September 20 meeting validates the outlook that seems to underpin the investment strategy of LGIP and money fund managers: one more 25 basis point rate increase likely but not certain between now and year-end.
The modest extensions prior to Wednesday’s FOMC announcement allowed fund managers to take advantage of a recent flood of new Treasury bills into the market and some steepening of the short-term money market yield curve.
The yield catch-up of LGIPs is a fact of life as LGIP yields lag those offered by direct investment in money market securities. A pool with a WAM of 30 days would normally take nearly a month before the posted seven-day yield fully incorporates rates that change because of Fed action or other market events. Thus, by early September yields had largely caught up with the market and should not exhibit great changes unless/until the Fed next acts.
The back story. LGIP and money market fund managers reduced WAMs in late 2021 and early 2022 as the Fed began to raise rates from their level of nearly zero. Early this year, with rates rising rapidly and bank problems agitating the markets, weighted maturities were generally reduced to the mid 20-day range for stable value LGIPs and money market funds. Short WAMs buffered the effect of rate moves on net asset values and minimized the lag between Fed interest rate increases and the rise in pool rates.
Current WAMs in the 30-to-40-day range provide some opportunity for additional repositioning of portfolios between now and the next FOMC meeting scheduled for early November.
LGIP holdings tracked by S&P show little change in allocations to market risk sectors in September compared to June.
The following chart shows sector allocations:
Government portfolio risk. Government LGIPs rated by S&P held nearly 40% of their assets in repurchase agreements, 30% in Federal agencies and 18% in Treasuries in the week ended September 1. The balance was in bank deposits and money market funds. Thus, there was little credit-related market risk. New issue Treasuries deluged the market over the summer and these LGIPs took advantage of what were attractive relative rates by increasing Treasury holdings and reducing allocations to repo.
These portfolios have high liquidity. S&P does not report portfolio liquidity statistics but assuming that the Treasury, repurchase agreement and Agency holdings are liquid could mean that more than 80% of these portfolios would meet the Securities and Exchange Commission’s definition of weekly liquidity.
To confirm this view of liquidity, we look at two large government pools, managed by Federated and Fidelity that report liquidity directly on their websites. Federated-managed Texpool (roughly $29 billion in assets) reported 48% in daily liquidity and 66% in weekly liquidity as of September 1. Fidelity-managed North Carolina Capital Management Trust ($17.8 billion in assets) reported 72% in daily liquidity and 76% in weekly liquidity as of September 1.
Prime LGIP portfolio risk. S&P reported that prime portfolios it tracks held 66% of assets in credit instruments. The balance was in government obligations (including repurchase agreements) as of September 1. These pools have greater credit-related market risk than government portfolios. Portfolio holdings of credit instruments was virtually the same compared with June.
As noted, liquidity is not disclosed systematically by LGIPs, but Federated’ s Texpool Prime portfolio (nearly $13 billion of assets) reported 34% daily liquidity and 67% % weekly liquidity as of September 1.
For comparison, prime money market funds had a lower credit allocation than prime LGIPs, totaling 61% of portfolio assets as of August 31 and reported to the SEC daily liquidity of about 50% and weekly liquidity of 66%.
The bottom line. Cash has been king through the Fed’s tightening cycle and as long as the central bank maintains a slow pace of tightening and the economy avoids recession, cash is likely to be a top- performing investment vehicle. Those investors who have the capacity to access high quality short-term securities directly will find an advantage over LGIPs and money funds that invest in these same assets but charge a fee to intermediate between the market and investors. But for the vast majority of investors who lack the resources/expertise, LGIPs and money market funds appear to be well positioned to take advantage of current market opportunities and minimize risk.