The Securities and Exchange Commission (SEC) passed new rules governing money market funds in mid-2014. These rules are designed to combat potential liquidity problems should the economy experience another financial meltdown on the order of 2008-2009. Traditionally money market funds have been the place where many investors park cash. Shares of the funds maintained a constant $1 per share value and there was immediate liquidity. The new rules will change some of these attributes for some money market funds. Here is a guide to the new rules and where they will apply. (For more, see: Introduction to Money Market Mutual Funds.)
Certain money market funds will have a floating net asset value (NAV) once the new rules take effect. These funds will no longer be priced at a constant $1 per share. This will impact institutional municipal money market funds and institutional prime/general purpose money market funds only. Retail money market funds will not be impacted by this rule.
The new rules call for two types of liquidity fees that could impose pretty stiff fees on redemptions, especially for these traditionally low return vehicles. If the money market fund’s weekly liquid assets fall below 30% of the fund’s total assets then the board of directors of the fund may impose a 2% fee on fund redemptions. If the money market fund’s weekly liquid assets fall below 10% of the fund’s total assets, redemptions would be subject to a 1% percent redemption fee unless the board of directors votes otherwise. Both institutional and retail municipal and prime/general purpose money market funds are subject to these new rules. (For more, see: Do Money Market Funds Pay?)
If a money market fund’s liquid assets were to fall below 30% of total assets the fund’s board of directors will be allowed to vote on whether to restrict all fund redemptions for 10 days. Given that money market funds are typically used for their low investment risk and liquidity the imposition of redemption gates could be problematic for many investors.
U.S. Treasury money market funds and funds that invest only in U.S. government issued securities are exempt from the new rules including the floating NAV, redemption gates and redemption fees. This may result in these being the money market funds of choice for many investors going forward. (For more, see: Understanding Financial Liquidity.)
Retail money market funds are essentially owned by individual investors. Note that money market funds offered within a 401(k) are deemed to be owned by individuals as well. Institutional money market funds are defined as being open to any shareholders including individuals, corporations, small businesses as well as institutional accounts such as those for endowments and foundations. (For more, see: How to Invest Like an Endowment.)
Municipal money market funds investment mostly in municipal and other government money market and fixed-income vehicles that provide tax-exempt income either at the national level or for a particular state. Governmental money market funds invest in governmental securities, while U.S.Treasury money market funds invest in Treasury instruments. Prime or general purpose money market funds invest across the spectrum of government securities and non-governmental money market instruments.
Implications for investors
Fidelity Investments is in the process of asking shareholders to approve the conversion of three of its money market funds to governmental funds in order to avoid the new rules and restrictions. While it is likely that many investors will prefer governmental money market funds that will allow them to avoid the floating NAV and redemption restrictions, it is also likely that these money funds will offer lower rates of interest going forward.
Certainly for funds that will be needed in the near-term money market funds will remain a viable option, especially the governmental funds. However in many cases investors and financial advisors might look at other options for the lower risk, shorter-term fixed income portion of their portfolios. These might include short-term bond funds and other alternatives. (For more, see: The Pros and Cons of Money Market Funds.)
Another option that many broker-dealers are considering is moving their client’s sweep account away from money market funds altogether and into bank deposit programs offered via banking affiliates.
Alternatives With Added Risk
Since the announcement of these new rules at least a dozen new short-term bond mutual funds have been launched including Vanguard’s Ultra Short-Term Bond Fund (VUBFX), although according to Vanguard the launch was not related to the new money market fund rules. (For more, see: Pimco vs. Vanguard: A Comparison.)
Short-term bond funds will offer a higher yield than money market funds but also carry more market risk based on their underlying holdings. According to Morningstar Inc. (MORN) the average ultrashort-term bond fund lost 7.89% during 2008. Financial advisors would be wise to remind clients seeking a bit more yield of the potential risks of assuming these funds are a substitute for money market funds.
The Bottom Line
In an attempt to prevent a collapse of our financial system in the event of another economic meltdown on the order of the financial crisis of 2008-2009, the SEC passed a number of changes in the rules governing money market funds. Some funds will have redemption fees imposed upon shareholders in certain cases, while others will see their NAV be allowed to fluctuate from the traditional stable $1 per share. These changes will force investors and financial advisors to reexamine how they use money market funds and also to look for alternatives. (For more, see: Why Money Market Funds Break the Buck.)