Fitch Ratings says that investors are accepting negative euro money market funds' yields, as they face the lack of low-risk alternatives and amid heightened risk aversion at a time of market stress, as was the case over the summer. In its latest quarterly report on European MMFs, Fitch also highlights active adjustment by fund managers to their modest Volkswagen AG exposure ahead of the issuer's downgrade.

Outflows from euro constant net asset value (CNAV) funds halted in 3Q15 despite their negative yields, which are in line with short-term euro market rates. These funds even saw modest inflows over the quarter following three months of outflows after funds' yields turned negative in April. This highlights investors' acceptance of negative yields, especially at a time of market stress, as was the case over the summer. Overall CNAV MMFs assets declined 2% to EUR526bn over the quarter.

The trend was similar, albeit more volatile, in French variable NAV funds' assets (EUR313bn at end-September 2015), the second largest segment of European MMFs, which are almost exclusively euro-denominated.

Fitch-rated European money funds actively adjusted their exposure to Volkswagen AG securities in response to negative news flow and Fitch's Rating Watch Negative on 23 September, from an already fairly low base, primarily by ceasing new purchases rather than through outright sales. Volkswagen AG was subsequently downgraded to 'BBB+'/Negative/'F2' on 9 November 2015. Exposure to Volkswagen AG in Fitch-rated MMFs was modest (with a maximum fund allocation of 1.8%), short-dated and present in only three funds as of mid-October 2015.

In Fitch's opinion these positions on Volkswagen AG represent minor and temporary deviations from its rating criteria, especially as the 'F2' downgrade does not reflect a deterioration of the issuer's short-term liquidity profile (https://www.fitchratings.com/site/fitch-home/pressrelease...). However, if any fund actively increases its exposure to Volkswagen AG securities or extend maturities this could lead to a downgrade.

Financial issuer exposure reached new lows in European MMFs at 68% at end-September 2015 after almost two years of steady decline. It fell by an aggregate 10.4 percentage points over the last seven consecutive quarters. The sector mix of funds has gradually shifted from financials to sovereigns, supranationals and agencies (SSAs), and, most markedly for euro funds, to non-financial corporates. This has been a function of reduced short-term supply from banks due to Basel III liquidity ratio requirements, more regular high-quality corporate issuance and the attractiveness of the SSA sector for MMFs due to its high credit quality and liquidity. Financials, however, remain MMFs' largest overall allocation.

US dollar-denominated MMFs shortened their average maturities through 3Q15 in anticipation of a possible rate hike by the Fed. Although the Fed funds rates were left unchanged, portfolios' weighted average maturities remained low until the end of the quarter, at 32 days.

The average euro MMF gross yield has stabilised since early August after the marked decline in 2Q15 when yields started to turn negative. It stood at negative 0.06% in mid-October, a 3bp decline from the previous quarter, in line with the euro LIBID change. In contrast, gross yields on US dollar and sterling funds increased on average to 0.57% and 0.27% respectively, representing an increase of 2bp and 4bp over the quarter.

More volatility was seen in 3Q15 in individual fund's weekly net investor flows, which emphasises the importance of high portfolio liquidity so that portfolio profile does not get distorted. Overnight and one-week portfolio liquidity generally remained high in 3Q15.