Money market funds become even less appealing

David Peartree, The Daily Record Newswire

The more federal policy fiddles with money market funds the less appealing they become for investors. Money market funds have long been viewed as a boring place to stash cash in a portfolio. Recent changes in the rules governing money market funds are intended to make them less risky for the financial markets but at the price of making them more risky for individual investors.

Federal Reserve action on interest rates over the past six years has limited the returns for money market funds to virtually nothing. The average yield currently is about 0.03 percent. Back in 2007 the average money market fund yielded close to 5 percent.

Money market funds represent a $2.7 trillion slice of the financial markets. These funds provide much of the short-term financing for corporations and governments, and therein is the concern of the regulators.

In the chaos of the 2008 financial crisis, the stability of many money market funds was in doubt and the federal government had to step in to prevent a cascade of redemptions by investors. One of the oldest money market funds then in existence, the Reserve Primary Fund, failed to maintain its $1 per share value.

This is known as "breaking-the-buck" and it spooked the market. The resulting run of redemptions in the institutional money market threatened to bring this important part of the credit market to a grinding halt. In response the U.S. Treasury created a temporary guarantee program for money market funds to reassure investors and calm the market.

Although the Reserve Primary Fund was the only one that technically "broke-the-buck," the Federal Reserve Bank later reported that a number of other funds would have done the same had not the sponsors of those funds stepped in with their own money to cover losses.

For the past six years the SEC has been debating the systemic risk that money market funds pose to the financial systems and the steps to take to minimize that risk. The concerns in 2008 focused primarily on institutional money market funds, those that cater to corporations and other institutional clients. The new rules, however, will affect both institutional and retail investors.

First, the new rules will require institutional money market funds to abandon the long-standing practice of maintaining a stable value of $1 per share and to move to a floating net asset value (NAV). A floating NAV will mean that share prices will adjust daily based on the market value of the underlying holdings.

The objective of the new rule is to make the market risk apparent to investors. The rule aims to destroy the illusion that money market funds are the same as cash and to scratch any expectation that the U.S. government will guarantee them. The hope is that changing investors' expectations now will prevent a panicky run of redemptions during the next financial crisis.

The new floating NAV rule will not apply to "retail" funds, meaning those that are restricted to individual investors only. That would seem to mean that individual investors need not worry about this, but money market funds that are open to both institutional and individual investors will be subject to the floating NAV.

The second important change involves new restrictions on redemptions that will apply to all investors. The rules will allow a fund's board of directors to impose redemption fees and to suspend redemptions under certain circumstances.

If a fund fails to meet certain liquidity tests, the fund's board may impose a redemption fee of up to 2 percent. In addition, a fund may suspend all redemptions for up to 10 days in any 90-day period.

The new rules don't take effect until later in 2016, giving investors time to reassess how they will use money market funds in the future.

First, investors should recognize that market funds are not the same as cash. Money market funds are mutual funds. They represent a basket of very short-term and, hopefully, high quality fixed-income instruments. They do not benefit from FDIC protection. Investors may use money market funds as a substitute for cash but they need to acknowledge that they are not the same as cash.

Second, money market funds do carry risk. A floating NAV simply makes evident the market risk that has always been present. Redemption fees and other restrictions on redemption are forms of liquidity risk. An investor is free to conclude that none of these risks are substantial, but it would not be wise to ignore them altogether. The paltry yields on money market funds don't compensate investors to take any risk.

Third, investors can seek alternatives. Many brokerage accounts offer FDIC insured bank deposits or brokered certificates of deposit. U.S. government money market funds will avoid the floating NAV rule but won't necessarily avoid the redemption restrictions.

Be informed. Knowledge mitigates risk.


David Peartree, JD, CFP® is the principal of Worth Considering Inc., a registered investment advisor offering fee-only investment and financial. Offices are located at 160 Linden Oaks, Rochester, N.Y. 14625,

Published: Fri, Apr 17, 2015