Finance executives that steer their companies’ short-term cash investing strategies take note: money market funds holding your surplus cash may be headed for a downgrade.

Moody’s Investors Service has revised its outlook for the money market fund (MMF) industry to negative from stable, saying the number of funds rated “Aaa” was likely to decrease in 2015. The action by Moody’s promises to make next year even tougher for money market funds, which were already becoming less attractive to institutional investors and corporates because of new U.S. regulations and proposed rule changes in Europe.

Moody’s said the change in outlook “reflects the rating agency’s expectation that, despite cautious investment approaches, MMFs will struggle to maintain the highest credit and stability profiles in 2015 due to an ongoing supply and demand imbalance, low to negative net yields of funds and elevated asset flow volatility.”

Moody’s analysts are predicting greater risk taking by money market funds, due to a shortage of high-quality, short-term investments. “Rising investor demand for high quality short-dated investments combined with banks’ deleveraging and reduced dependence on wholesale funding has resulted in much tighter supply conditions, which will push more MMFs to extend their investment tenors in pursuit of yield, and potentially move down in credit quality,” according to Robert Callagy, a senior analyst at Moody’s.

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MMFs with longer tenor and lower quality investments “increase their susceptibility to liquidity risk, a credit negative,” said Moody’s and “the severity of this risk has increased in the current market environment where availability of secondary market liquidity is an emerging concern due to the significant declines in broker-dealer security inventories.”

Monetary policy normalization in the United States and the United Kingdom will be another obstacle. “Following initial rate hikes, U.S. and U.K. MMF balances will fall, as MMF yields will temporarily lag market yields on direct investments.”

Also looming next year are the aforementioned changes to regulation. Specifically, prime funds, like mutual funds, will now have to let their net asset value (NAV) float — rise and fall along with changes in the market-based value of the underlying investments. In addition, the boards of money market funds will be allowed to impose “redemption gates” and “liquidity fees” — measures that presumably would halt or at least slow an investor exodus in a financial crisis

Moody’s said these changes to product structure in the United States will “cause investors to significantly reduce their exposure to prime funds, and even though the implementation of the reform is not due until Q3 2016, some shifts are likely to occur already in 2015.”

Featured image: Thinkstock

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