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Investing Blog published on October 7, 2016

For Short-Term Investing, One Size No Longer Fits All

For years, many cash investors have relied on money market funds (MMFs) as the short-term debt market’s darling for providing unshakable liquidity and capital preservation. Then in September 2008, markets experienced a sharp reality check during the global financial crisis, when the Reserve Primary Fund’s net asset value (NAV) startled short-term markets by dropping below $1 per share.[1] The fall in price of the Reserve Primary fund was just one symptom of a broader kerfuffle in pricing and liquidity in the short-term debt markets that prompted financial regulators to enact reforms such as the new money market fund rules with a compliance date of October 14.

The rules impact various types of MMF investors and cause a range of issues to arise for investors using MMFs as a short-term solution.

  • Prime MMFs Targeted to Institutional Investors: The rules require institutional prime MMFs to move from a stable $1 NAV to a floating NAV, meaning that the funds’ share prices will reflect the true value of fund assets. The rules also allow MMFs to institute redemption gates and fees in times of market stress. Specifically, MMFs can impose a liquidity fee of up to 2 percent or even suspend redemptions altogether for up to 10 business days in a 90-day period if the MMF’s weekly liquid assets fall below 30 percent, under the discretion of the MMF’s board. Additionally, the MMF will be required to impose a fee of 1 percent on all redemptions if its weekly liquid assets fall below 10 percent, again under the discretion of the MMF’s board. Institutional investors seeking to match their assets with their liabilities may find prime MMFs less attractive because the stability of the $1 NAV has been replaced by a floating NAV. Other issues include the technical and operational complications of instituting a floating NAV, the potential fees/gates that may come about in distressed markets and the overall concerns that capital preservation is compromised.
  • Prime MMFs Targeted to Retail Investors: While retail prime MMFs will remain fixed at $1 NAV, they will be subject to the same redemption gates and fees as institutional prime MMFs. With liquidity gates and fees, retail investors in prime funds could face situations in which they need cash quickly but are unable to make a withdrawal or are hit with fees upon withdrawal.
  • Government MMFs: Government MMFs are not subject to the floating NAV requirement. Government MMFs are permitted, but not required, to impose fees and gates.


Key Takeaway: Be More Thoughtful about Cash

While regulators ushered in the reforms to help stave off further liquidity issues in short-term markets, the changes have also prompted a mass exit from prime funds into government funds[2] and many institutional and retail investors wonder whether they should follow suit or seek some other solution for their cash needs. In our view, the “right answer” will vary based on the needs of each individual. MMFs, once thought of as a “one size fits all” solution for cash needs, now have been stripped of their simplicity by the new regulation.

Indeed, the rules necessitate a more thoughtful approach to investors’ cash needs and risk/return profiles. It’s not an easy time to manage cash and decide on the best short-term strategies, and perfect substitutes for prime MMFs are not readily available in the market. However, investors can benefit from looking carefully at their goals and working with their advisors to determine the best fit in the new cash environment.


[1] “Report of the President’s Working Group on Financial Markets. Money Market Fund Reform Options,” October 2010. The Department of the Treasury, The Federal Reserve, the SEC, and the Commodity Futures Trading Commission.

[2] iMoneyNet, as of October 5, 2016.

 

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