The Securities and Exchange Commission is considering eliminating the stable, $1 net asset value (NAV) requirement that money market mutual funds have long held, by either making the funds have a floating $1 NAV or a $10 NAV.
While such a move could help prevent future run-on-the-bank scenarios that several funds experienced last September, mutual fund industry advocates warn that eliminating the stable $1 NAV would take away the only thing that makes these products desirable to investors.
"A $10 NAV makes it 10 times easier to break the buck," said Peter Crane, president and CEO of Crane Data LLC. "I don't think making the buck 10 times easier to break will be better for investors. It wouldn't prevent a run; it would start the run earlier. We could see a mass exodus into banking products."
Others argue that a money market fund without a stable $1 NAV is no different than an ultra-short-term bond fund. Investors have shown little interest in these products lately, due to their much higher volatility.
Nonetheless, without a $1 NAV, trillions of dollars of assets could potentially leave the mutual fund industry for other sectors that are perhaps less suited to handle such traffic.
"It's too dangerous," Crane said. "The last thing anyone wants to do is destabilize segments of money market funds."
The Investment Company Institute's Money Market Working Group recently released its report on how money funds could self-regulate to fix the problem. The report emphasized the importance of maintaining the stable $1 NAV.
Money market funds have long provided a relatively safe and stable place for retail and institutional investors to park their cash, but because of traditionally low yields, investors have typically used these funds sparingly.
Just as water will take unexpected routes and slip through cracks on its journey to reach the lowest point, investors will gravitate toward products that serve their immediate needs, whether or not they were designed for that purpose. The disastrous performance of equities in 2008 sent investors scrambling for the safety of cash, engorging money funds with $731 billion in 2008. As of April 2, money market fund assets stood at $3.834 trillion, accounting for more than 42% of the total $9 trillion in mutual funds.
But when the Reserve's Primary Fund broke the buck last September, investors panicked and pulled $133 billion from prime money market funds in two days.
"Money market funds are susceptible to runs," said Robert Plaze, associate director of the SEC's division of investment management. "That run [in September] nearly resulted in a meltdown. Stopping that run was difficult and expensive."
The Treasury Department stepped in with a temporary guarantee on money funds-which was recently extended to next September-but the incident highlighted the need for changes.
"Funds have to have a system that allows investors to redeem at less than one dollar," Plaze said. "We've got to find a way for funds to be able to break a dollar and wind up redemptions" without having the funds freeze all the remaining assets.
"Money market funds' twin goals of providing liquidity, typically on a same-day basis, and preserving capital at times can conflict," said Andrew Donohue, director of the SEC's division of investment management. "In times of severe market turmoil, these twin goals may not be able to be achieved simultaneously."
While the NAV in most mutual funds changes daily with market movement, money markets funds are structured to maintain a stable $1 NAV, no matter what happens in the markets. During periods of extreme market losses, many fund companies have been forced to sell off other assets at reduced prices in order to maintain their money funds' $1 NAV.
These days, one of the only places where money funds can find trustworthy, stable value is in U.S. government Treasuries. There are so many investors crowding into these funds that yields have fallen to their lowest levels in 50 years. Many Treasury money market funds have closed to new investors, and some have even waived their usual fees and expenses in order to keep the funds from having negative yields.
"While the popularity of the stable $1 NAV is understandable, it does present certain potential drawbacks to investors," Donohue said. "When liquidity is at a premium, spreads may widen considerably, thus making it difficult to sell even the highest-quality instruments at or near amortized cost. A desire to maintain a $1 NAV can cause a fund to seek to delay redemptions or the payment of redemptions and thus fail to meet shareholders' expectations of liquidity."
Donohue said the $1 NAV makes money funds insensitive to small gains and losses, thanks to the somewhat deceptive practice of rounding to the nearest cent. This practice can create dramatic jumps once the small movements pass a critical point.
"While price changes can be expected to be infrequent, when they do occur, they will be fairly dramatic," he said.
For example, a fund that lost 0.40% on its investments would have a NAV of $0.9960, which can be rounded up to $1.00 and doesn't technically break the buck. Should a large investor see this and redeem 25% of the fund's assets at $1, the NAV would fall to $0.9947, which is rounded down to $0.99 a share, Donohue said.
"An investor purchasing at $1.00 when the NAV was $0.996 had no way to know that he or she was at risk of losing 1% in one day, merely because of redemptions by others or other minor valuation moves," he said.
"This lack of sensitivity to volatility affords investors-particularly large investors-the opportunity to take advantage of the fund and its shareholders. Sophisticated investors know this dynamic and will redeem their shares in the fund quickly, leaving the loss for the remaining shareholders."
Donohue said the $1 price does not provide investors with adequate enough information. He said these problems could be addressed by the adoption of a $10 NAV or a floating NAV to give money funds more breathing room when rounding to the nearest cent. But mutual fund advocates argue that a $10 NAV or a floating NAV would offer funds no incentive to maintain a stable value-and investors no reason to stay in them.
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