Have you ever made a deposit, a withdrawal, or held cash in your investment account? If the answer is “yes”, then there is a good chance that you’ve owned a money market fund (MMF). MMFs are short term, cash like investments that are often used as a way to earn interest on extra cash in an account. Although MMFs are often an overlooked part of an account, this segment of the investment industry has been undergoing some significant changes recently. Last Friday was the deadline for money market fund (MMF) providers to enact changes to be in compliance with a new set of SEC regulations. These changes have been in the works for several years and were designed with the intention of reducing risk in MMFs.
Why were these changes made?
The regulatory changes to MMFs stem from the 2008 Financial Crisis when one MMF, the Reserve Primary Fund, “broke the buck” during the height of the turmoil. One of the primary features of a MMF was that the net asset value (NAV) of the fund was always stable at $1 per share. Essentially, if you put $1 in then you can always get $1 out. This practice was accepted even though there are slight fluctuations in the market value of the securities because MMFs are invested in fixed income assets (e.g. U.S. Treasury’s, Agencies, repos, and commercial paper) that are close to maturity (the average maturity in a Government MMF was about 41 days according to the SEC’s most recent reporting). The Reserve Primary Fund had exposure to commercial paper and medium term notes issued by Lehman Brothers which defaulted, so the NAV of the fund dropped to $0.97 per share. This event caused investors to panic and resulted in wide spread redemptions across the MMF industry. After this happened, the U.S. Department of Treasury created an FDIC like insurance for MMFs to prevent the MMF equivalent of a bank run. The program was dissolved a year later without ever being used, but this event prompted the SEC to take additional steps to address the risk of runs on MMFs.
What changes were made?
The reform introduced three new features at the fund level: floating NAV, liquidity fees, and redemption fees. Several other restrictions were also put in place at the portfolio level to reduce the credit and liquidity risks of MMFs. Although these might seem like major changes, it is important to keep in mind that these features only apply to certain funds and in certain situations. A floating NAV is pretty straightforward. Instead of reporting each share constant at $1, MMFs must now report NAV based on the market value of the holdings. Liquidity fees of no more than 2% can be imposed for investor’s attempting to redeem shares if the fund’s weekly liquid assets fall below certain thresholds. The fund also has the option to suspend redemptions for up to 10 business days if these thresholds are breached. Although all this sounds like a major change, let’s explore whom these changes actually impact.
Whom does it affect?
As previously mentioned, these new features only apply to certain funds. For retail investors (i.e. a natural person), all MMFs will have a stable NAV. Funds that only own U.S. Treasuries or Agencies, which are classified as “Government” funds, do not have liquidity fees or redemption gates. Funds classified as “Prime” or “Municipal”, which have assets that are not U.S. Treasuries or Agencies will now have liquidity fees and redemption gates. However, these will only be imposed during times of extreme market stress, if at all. For institutional investors, “Prime” and “Municipal” funds will have a floating NAV as well as liquidity feed and redemption gates. “Government” funds will have a stable NAV and are not required to impose liquidity fees or redemption gates.
All of this can be a little confusing, so I’ve included a chart below.
What is APCM doing about it?
Over the last several months, APCM has been working closely with custodians to ensure that clients were transitioned into a money market fund that is most appropriate for their specific situation. We are also reviewing accounts on an individual basis to explore cash alternatives that will enhance the yield without materially increasing risk. Our team is always happy to share in greater detail how we are providing solutions in this area of the market, so please don’t hesitate to reach out if you have any questions about how MMF reform has impacted your portfolio.