Part of the lure of a money market fund has always been the stable $1 share price.
Put in a buck and you get it back, usually while earning some interest in between. There’s no insurance backing it, but otherwise it works similarly to a bank savings account.
Now the federal government is considering forcing money market funds to shift to a floating net asset value. In essence, the value of each share would then fluctuate day by day.
The Securities and Exchange Commission changed some rules earlier this year aimed at improving credit quality and liquidity of money market funds. But it also said then it would consider requiring fund companies to let their money market funds’ net asset values, or NAVs, float away from $1. Separately, the President’s Working Group on Financial Markets is also considering a similar requirement. No proposals have been made yet.
Investors Might Pull Out
The fund industry hates the idea, saying such a change would cause people to pull money out, doing severe damage to the funds and possibly putting the industry out of business.
The Investment Company Institute, the Washington, D.C.-based trade group for the mutual fund industry, is adamantly opposed to the idea.
Brian Reid, the ICI’s chief economist, said his group is mostly concerned a change would affect the strong demand for stable NAV money markets. That demand has held up even with interest rates so low that funds averaged a 0.11 percent yield in early August, according to Westborough, Massachusetts-based money market fund tracker Crane Data. Investors have $2.8 trillion in money market funds.
“That’s the market test,” Reid said. “It shows demand is out there.”
He fears the industry would be severely damaged if funds are forced to switch to a floating NAV. Institutions would likely form their own investment pools, and individuals would likely turn to banks.
“You would very likely see significant outflows,” he said.
Investors Want Stability
Brian Kalish, director of the finance practice at the Bethesda, Maryland-based Association for Financial Professionals, says the consequences will be even worse.
“We think it will pretty much kill the money market product,” Kalish said. “The reason investors buy money markets is for the stable NAV.”
Corporations use the funds to park cash for short time periods. Above all, they want to make sure they get their money back. If it earns a tiny bit in the meantime, that’s gravy. But if there’s a chance they won’t get it all back, they’re not interested, Kalish said.
Then there are the impacts on short-term debt issuers. Money funds play a big role in buying commercial paper that corporations issue, ICI President Paul Schott Stevens noted in a July speech. Without them, that funding source dries up. So does the short-term funding the money funds supply to municipalities.
“We don’t see who’s the winner,” Kalish said.
Wanted to Avert Panics
The change is being discussed as a way to make it less likely investors would make a run on a fund and quickly withdraw money. It’s also seen as a way to make it clearer to investors how much a money market fund’s assets are truly worth and how much risk is involved.
Andrew Donohue, director of the SEC’s division of investment management, said in a speech last year money market funds’ $1 share price doesn’t reflect shifts in value of the underlying assets. He said the stable NAV could cause investors to panic if they suddenly realized the fund’s assets were worth less than they thought. A floating NAV could solve that, he said.
But John Goetz, portfolio manager of the Cincinnati-based Touchstone Institutional Money Market Fund, one of the nation’s top-yielding money market funds, doesn’t believe a floating NAV will prevent runs on funds or give investors a better idea of a fund’s risk.
“That’s a leap of faith there,” said Goetz, who manages five money funds totaling about $900 million in assets. “I just think it creates more problems than it solves. I don’t think you gain any investor comfort.”
Floating Funds Not Popular
The ICI’s Stevens says the changes would have the desired effect. Ultra-short bond funds, which have floating NAVs and are the closest thing to money market funds, lost half of their assets in 2008, he said.
Almost no companies have launched floating NAV money market funds even though they’re already free to do so.
“Presumably, if there was strong demand, we would find a lot more of those products being brought out,” Reid said.
Little Risk Anyway
The SEC’s recent changes already do plenty to limit risk in money market funds, Goetz said. The regulator lowered the average maturity on investments from 90 days to 60 and tightened credit rating restrictions.
“Those changes limit the possibility that a fund price could deviate from a dollar,” he said.
It happens rarely anyway, Goetz said. There have been only two such instances since money funds were launched in the early 1970s, according to Goetz. However, Moody’s Investors Service recently said 36 U.S. money market funds were in danger of “breaking the buck” with their NAV during the 2008 financial crisis and had to receive financial support from their sponsor or parent company.
Goetz doesn’t expect the floating NAV requirement to happen. It’s more likely regulators will put more restrictions on funds, he said.
“It almost certainly would cause more harm than good,” said Peter Crane, president of Crane Data.
Steve Watkins ([email protected]) writes from Cincinnati.