Money market mutual funds have effectively served as cash reserve accounts for clients at banks, investment firms and institutions for the past several decades. These funds have become popular because they often pay higher rates than traditional savings accounts. And with very few exceptions, they have remained at a stable price of $1.00 per share throughout their history. However, that is going to change when the new money market rules go into effect on October 14. But advisors need to explain to their clients that the new rules are nothing to be afraid of.
How They Work
Money market mutual funds invest in money market securities with maturities of 270 days or less. These securities include T-Bills, commercial paper and repurchase agreements. Money market “prime” funds invest in a wide array of these instruments, including bankers’ receipts and deposits of eurodollars. There are also government money market funds that only invest in government offerings and Treasury money market funds that invest solely in Treasury securities. (For more, see: Impact of New Money Market Rules.)
But while these funds have almost always maintained a constant share price of $1.00, they are not guaranteed to do so by the government, the mutual fund company or anyone else. And the new money market rules will institute a floating rate on institutional money market funds, along with possible transaction fees and limitations on their redemption. Prime money market share prices will now be computed out to four decimal places. These funds are now quoting a “shadow” share price that is delayed by 60 days in order to show investors their true price in the markets without the arbitrary accounting rules that previously kept the price at $1.00 per share.
Institutional vs. Retail
But these rules will only apply to institutional money market shares, and not to retail money market accounts. Individual investors will see no change in their money market funds. “The money-market funds they use will price and transact with a $1 NAV,” Bob Litle, the head of intermediary sales at Fidelity Institutional Asset Management, told Investment News. This will be the case for prime, government and treasury money market funds. (For more, see: Plan Sponsors Face Money Market Fund Lawsuits.)
However, prime money market funds for retail investors will come with the same possible limits on redemptions as their institutional counterparts starting on October 14. Prime money funds will have two separate methods that they can use to limit redemptions if necessary. First, they can impose a fee of 2% on all funds that are liquidated within a limited period of time. They may also be able to delay redemptions for as long as 10 days. These rules also apply to tax-free money market funds that invest in short-term municipal securities.
Meanwhile, retail investors are faced with the choice of investing in a prime money market fund that comes with these liquidity limits and getting paid a higher rate or investing in another type of fund that will pay slightly less but retain total liquidity. Money market fund tracker iMoneyNet shows that the average prime money market fund is currently yielding about 0.17%, while the average government money fund is paying about 0.03%.
The Bottom Line
The changes that are arriving for money market funds are ultimately the result of the financial crisis of 2008. At that time, the Reserve Primary Fund, the nation’s first money market mutual fund announced that it could not keep its fund price at $1.00 and the markets reacted violently. The money market industry as a whole essentially ground to a halt, and the Federal Reserve had to take action to get it going again. The new rules are therefore designed to allow for greater flexibility in the share price of institutional money market shares in order to prevent this from happening again. But retail investors won’t be affected by these changes. (For more, see: Money Market Mayhem: The Reserve Fund Meltdown.)