The $1 trillion pile of cash that investors amassed amid the pandemic-fueled market turmoil may determine the length of the risk rally.

U.S. money-fund assets have started to shrink from a record high. Roughly $72 billion has exited after three weeks of outflows, the longest such streak in more than two years, Investment Company Institute data show. The shift coincided with emerging signs of an economic recovery that drove the S&P 500 Index to the highest since February, and a historic rush into fixed-income exchange-traded funds as the Federal Reserve supported that market.

A lot is riding on whether the incipient move out of cash, where it’s earning virtually nothing, continues. On the one hand, it’s an obvious potential source of additional fuel for the already-booming rebound in risk assets. But with virus worries mounting yet again, it may be premature to expect a major exodus anytime soon. A Deutsche Bank AG analysis shows that investors on edge over the pandemic have been sticking much more stubbornly to their cash holdings relative to past market crises.

“It’s indicative of just the uncertainty and the fear investors have,” said Peter Yi, director of short-duration fixed income and head of credit research at Northern Trust Asset Management. “In another respect, it makes you think that all this cash on the sidelines is potentially the powder that could bring the next leg up in risk assets when there is more clarity around how things are going to play out.”

Assets in money-market mutual funds are still at a near-record $4.72 trillion, after soaring from $3.7 trillion in early March as the spreading virus battered stocks. At its peak, more than three-quarters of that was parked in Treasury-only and other government funds -- which are perceived to be the safest of these portfolios.

Equities plunged into the fastest bear market on record in March, when a credit crunch saw investors unload even their highest-quality holdings to raise cash. A raft of emergency monetary and fiscal measures have stoked markets in the months since. The S&P 500 has surged nearly 40% since March 23, while the Fed’s foray into the corporate bond market boosted BlackRock Inc.’s iShares iBoxx $ Investment Grade Corporate Bond ETF to an all-time high.

ETF Echo
The $4.3 trillion ETF industry is echoing the same caution seen in money-market funds. Fixed-income ETFs have taken in about $83 billion in 2020, outpacing the $73 billion of inflows into their equity counterparts, according to data compiled by Bloomberg. Equity ETFs hold $3.3 trillion, compared with $951 billion in fixed-income funds.

“You put that together with being in cash, it does paint the picture of investors essentially not being optimistic about the market, and maybe not being optimistic about the economy,” said Alicia Levine, chief investment strategist at Bank of New York Mellon. “I suspect some of that money will find its way to the equity market.”

Even within money funds, there are signs that investors are willing to slowly take on more risk. Assets in prime funds -- which offer slightly more yield because they can also hold corporate obligations -- have risen the past 10 weeks, according to ICI data. Prime funds have added about $107 billion from a near one-year low in early April, rising to $761 billion. Government funds have declined to about $3.8 trillion, from a record $3.92 trillion in early May.

Not everyone is convinced the accumulated cash will stream back into equities. Assets have been building in money-market accounts for decades, a trend that appears to accelerate during recessions, according to Ed Keon at money manager QMA. However much returns to risky assets, it won’t be enough to build a bullish case on, he said.

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