Cash continues to pour into money funds and stable value local government investment pools. Assets of the stable value LGIPs rated by S&P Global grew by $71 billion or 23% in the 12 months ended February 9, 2024 to nearly $377 billion. Assets of money funds tracked by the Investment Company Institute rose to $6.001 trillion at the end of last week, up about $1.2 trillion, or nearly 25% in the past year.

While recent growth trends are similar, Since January 1 LGIP assets have expanded by $31 billion or nearly 9%, far faster than year- to-date growth in money funds, which has been about two percent. Seasonal factors may play a role (see the accompanying chart) as a number of large states receive tax receipts in the December-February period.

Where the LGIP cash is coming from and how long it will persist is not entirely clear. Among the possibilities:

• Bank deposits. Deposits from all sources declined by $193 billion in the last 12 months. This includes public funds deposits that declined by about $15 billion in the first nine months of 2023. Banks generally have not raised deposit rates to keep up with the investment market, so depositors have sought other alternatives. But shifts from banks to LGIPs might account for only a small part of the $71 billion increase in LGIP assets.

• Tax and other revenue receipts. State and local government tax receipts were essentially unchanged in the 12 months ended September 2023, after they rose sharply in the post-Covid recovery.

The National Association of State Budget Officers reported a mixed picture at the state level, with expenses in FY 2024 budgeted to rise 6.5% but revenue down 1.8%. State cash balances should suffer from these trends, but intergovernmental transfers to local governments could be up vs. 2023. Meanwhile payments under the American Rescue Plan Act swelled state and local government cash in 2021 and 2022. These funds must be spent by December 31, 2026, so this year is likely to see draws on cash for this program. Overall, it is unlikely that cash balances were swelled by revenue growth. Indeed, it is likely that spending in excess of revenue led to some draw down of investment balances over the past year—a trend that could continue and accelerate in coming months.

• Reallocation of cash to stable value LGIPs. Allocation of assets into LGIPs from maturing investments that may have had original lives of one to three years—or longer—likely is the major source of LGIP asset growth. The sharp rise in short-term rates over the past two years means that LGIP yields stand out on the leaderboard. The best rate today is likely to be the shorter maturity investments.

Investors who go with the best rate they see could prefer an LGIP. So would investors who were disappointed by the volatility and low returns of fixed income portfolios over the past two years and want to avoid the possibility of unrealized losses in maturities beyond the LGIP time horizon. One sign of the preference for short- maturities is contained in a Fitch report on LGIP trends that includes asset estimates for both stable value and longer-duration pools. Fitch totaled $34.9 billion of inflows for these pools, $25 billion into stable value LGIPs and only $10 billion into longer-duration funds.

The Bottom line: Cash has reigned supreme for the past two years and stable value LGIPs, which currently advertise yields in the range of 5.25%-5.50%, demonstrate this. They are attractive because very short-term yields are higher than those with longer maturities—the yield curve is inverted. It has not been so inverted for more than 20 years—the working lifetime of many investment professionals.

An investor must “give up” yield to invest for a longer term—something that seems to defy logic. Of course, if/when the Federal Reserve begins to cut short term rates, longer-maturity investments that might have been acquired at current yields will suddenly be very valuable—but also not available. Investors who have parked cash in LGIPs (and money funds) appear to be betting that short term rates will remain elevated for some time.

Briefly noted

Washington now permits county investment pools to accept funds for investment from tribal governments. HB 1352, effective July 23, 2023, authorizes these investments alongside investments of local governments. The state treasurer also operates a pool for local governments, and tribal governments can invest in the state pool. The state’s pool operates in a manner similar to a Rule 2a-7 fund with a stable net asset value and short average maturity. County pools tend to have longer maturities, so this law provides another investment vehicle with a different investment horizon.