One of the key selling points of money market ETFs is that of offering investors the possibility to equitise cash holdings at very low cost without incurring a significant level of risk. By definition, a money market fund will privilege capital preservation over returns; aiming at best to marginally better prevailing money market rates. As such, the comparative low cost of ETFs vs. traditional money market funds should be appealing for investors seeking a flexible vehicle to put excess cash to work, particularly in short-term horizons.
According to Morningstar data, the standard annual management fee of a Eurozone money market ETF is at the top-end of a 0.05-0.15% range and compares favourably to the fees charged by around 70% of the 100 largest traditional open-ended money market funds domiciled in the Eurozone which range from 0.02% to 1.10%. However, despite the comparative advantage in cost terms and the flexibility afforded by the real-time on-exchange tradability of ETFs, the market share captured by European money market ETFs, remains a very small fraction of that of traditional funds. Money market ETFs are relatively new in the European ETF landscape, with the first Eurozone offering (e.g. db x-trackers II Eonia 1C) launched in June 2007. This is indeed a brief history when compared to long-running traditional funds, some of which can be traced back to the mid-to-late 1980s.
As we write, the number of Eurozone money market ETFs is nearing 20, with the two largest (e.g. db x-trackers II Eonia and Lyxor ETF Euro Cash) having AUM in the EUR 1.2-1.3bn area. These figures pale in comparison to the over 3,300 open-ended Eurozone money market mutual funds, with the 100 largest all exceeding the most popular ETFs in AUM terms. In the UK, money market ETF presence is best described as testimonial. The timing issue, as well as the limited number of ETF providers, go a long way into explaining the development of money market ETFs. However, there may have also been structural causes borne out of the way most money market ETFs (note – we shall focus on the Eurozone) are built that have translated into a fairly unrewarding performance over the last two years and might have ultimately undermined their development. 
There is no uniform definition as to what best represents the essence of the money market, but the majority of Eurozone money market ETFs opt to replicate the return of a rolling deposit invested daily at Eonia (i.e. the overnight reference rate for the Euro computed as a weighted average of all overnight unsecured lending transactions undertaken in the banking system). Historically, Eonia has tracked the ECB main refi rate, but since the onset of the financial crisis it has been tracking the much lower deposit rate, currently 0.25%. This has been a direct result of the ECB liquidity provision efforts to keep the interbanking system rolling. As private banks have been very reluctant to lend to each other, ample excess liquidity has been making its way back to the ECB via its deposit facility, in the process forcing Eonia down to track the ECB’s deposit rate. The spread between Eonia and the ECB deposit rate narrowed from its pre-crisis average of around 105bps to just 10bps in H2-2009 and H1-2010. Returns of money market ETFs tracking Eonia have of course followed the same path, in the process making them financially unattractive for cash equitisation when compared to alternatives, whether ETF or not, involving a similar low level of risk but offering rates of return close or above the ECB refi rate.
It would seem clear that for money market ETFs to establish themselves as serious contenders for investors’ cash equitisation purposes we need money market dynamics to revert to pre-crisis settings. Although very tentative, some encouraging signs have been noted over the last few months. Eonia has been more volatile and trending higher since the expiry in July of the ECB’s last 12m refinancing operation. But this has also been facilitated by a decrease in private banks’ recourse to the ECB deposit facility. As a result, the Eonia-ECB deposit rate spread widened to 20bps in Q3-10 and further up to 44bps in October.
In principle this signals that financial markets may be pricing in the full phasing out of the ECB’s non-standard liquidity provision measures, which would put further upward pressure in Eonia, in turn pushing up returns on Eurozone money market ETFs. However, at this stage the markets continue to see this as a long-term prospect. Quotes taken after the ECB’s policy meeting on 4-November showed Eonia hitting 1.00% only at end-2011. The ECB may be tired of what it describes as “addicted banks”, but the road towards normalisation of money markets remains filled with bumps (e.g. new bout of sovereign debt crisis) that could easily knock it off course.
For money market ETFs to establish themselves as attractive option for investors’ cash equitisation we need money market dynamics to revert to pre-crisis settings
