Pending regulations aimed at money market funds could make these vehicles less attractive to buyers seeking liquidity and stability, two traits that have long been their calling card. However, corporations in need of cash are offering bigger yields to make up for those restraints, a fact that seems to be luring a whole new group of investors to the sector. (For more, see Money Market Funds: Enough Regulation Already?)
Money Market Fund Share Prices to ‘Float’
Starting in October, institutional prime money market funds – those that invest in short-term commercial paper as well as government notes – will no longer be able to guarantee a $1 per share price. Instead, the value will have to “float,” based on the current market price of their holdings. Also, should their liquidity levels fall below a pre-determined limit, they will be forced to impose fees on redemptions. Funds that cater to the individual investor can maintain their fixed-asset price, but they will have to impose redemption fees during periods of market turbulence. The changes are a response to the 2007-2008 financial crisis, when several prominent money market funds, including the colossal Reserve Primary Fund, “broke the buck,” forcing investors to accept less than $1 a share.
Money Managers Looking Elsewhere
In light of the new rules, some money managers have started pulling money out of the money markets. Over the past year institutional investors have transferred roughly $500 billion in prime fund assets to government-issued notes, which aren’t subject to the new regulations, according to Reuters. That number could total $900 billion in the weeks ahead. (For more, see Do Money Market Funds Pay?)
Some Notes Sweetening Yields
Borrowers in need of cash have responded by sweetening the yields on short-term notes. A year ago the interest rate on a three-month AA-rated commercial paper was just below 0.3%. Now those same instruments offer roughly 0.7%. Investors have been able to snag six-month paper with even higher yields, sometimes eclipsing 1%. Getting that high a payout on an instrument with such a short time commitment was inconceivable just a few months ago.
Figure 1. The yield on commercial paper – short-term bonds that represent the backbone of many money market funds – has been rising due to pending regulations.
Source: Federal Reserve
Money Market Fund Alternatives
While there’s renewed interest in money market instruments among those hunting for yield, there’s still a question as to whether they’re the best bet for risk-averse investors. Certificates of deposit (CDs), for example, provide nearly as high a return for those willing to have their cash tied up for a short period of time. CDs also have a big advantage that money market funds don’t: They’re backed by the Federal Deposit Insurance Corporation (FDIC). That means you can rest assured that your initial deposit is protected no matter what happens in the financial markets.
If you’re looking for a little more liquidity, online savings accounts are also a compelling option. Ally Bank, for instance, offers 1.0% APY on its accounts. These likewise come with FDIC backing, and there’s no minimum balance to boot.
Finally, for folks who want a nice, safe asset for their corporate retirement account, a stable-value fund is another alternative. These vehicles invest in bonds that have a longer duration than money market funds, allowing them to generate bigger returns. However, they’re paired with an insurance component (though not through the FDIC) that guarantees a minimum return should the market decline. Historically, stable-value funds, which are available in many 401(k)-style plans, have outperformed money market funds, even though their risk profile is similar.
The Bottom Line
The yield on money market funds is higher than it’s been in a long time. The trade-off is that new government regulations bring slightly less safety and liquidity than in the past. And be aware that there are a number of FDIC-insured options that offer comparable yields without any of the worries. (For more, see 2016’s Most Promising Money Market Funds.)