Recently, some have expressed concerns about issues with "shadow NAVs" once money funds begin reporting these statistics early next year. (See Crane Data's May 6 News "CFOs, Treasurers Should Prepare for Big Changes in MMFs Says AFP" and Peter Crane's AFP Webinar, "Money Market Mutual Funds: New Regulations and Outlook for Change".) While we dismiss fears about any "shadow" NAVs of $0.9999 being interpreted as "breaking the buck," we wanted to discuss the issue in a little more detail and cite some other recent comments on the matter below.
The SEC's New Money Market Reforms explains the current regime, "In addition, the rule includes certain procedural requirements overseen by the fund's board of directors. One of the most important is the requirement that the fund periodically 'shadow price' the amortized cost net asset value of the fund's portfolio against the mark-to-market net asset value of the portfolio. If there is a difference of more than one-half of one percent (or $0.005 per share), the fund's board of directors must consider promptly what action, if any, should be taken, including whether the fund should discontinue the use of the amortized cost method of valuation and re-price the securities of the fund below (or above) $1.00 per share, an event colloquially known as 'breaking the buck.'"
The new Rule 2a-7 changes say, "Money market funds also must report on Form N-MFP the market-based values of each portfolio security and the fund's market-based net asset value per share, with separate entries for values that do and do not take into account any capital support agreements into which the fund may have entered." The new reported shadow NAVs will begin appearing (in a format that only a computer will love) in early February 2011, 60-plus days after month-end November 2010. Expect to see values ranging from 1.0003 to 0.9991.
The Commission explains, "We anticipate that, during the 60 days between the end of the reporting period and public availability of the information, funds will take steps to resolve issues that may raise concerns with investors and analysts. In addition, because money market fund portfolios have a limited maturity, many of the portfolio securities will have matured by the time the information is released to the public. Thus we expect that the 60-day delay will ameliorate many of the risks associated with public disclosure. We also expect that, over time, investors and analysts will become more accustomed to the information disclosed about fund portfolios, and thus there may be less need in the future to require a 60-day delay between the end of the reporting period and the public availability of the information. We therefore may revisit in a subsequent release whether to retain the same (or any) delay in public availability of this information."
Recently, Federated Investors Debbie Cunningham wrote in a piece entitled, "Market Memo: 'Shadow pricing' will lift the veil off benefits of $1 NAV," "[W]hen it comes to money market mutual funds, 'shadow pricing' in many ways is just the opposite -- it is a very precise calculation of money fund asset's net asset value (NAV). Simply put, it's the mark-to-market price of the money market fund."
She explains, "It sounds dramatic, but it really isn't. Because money fund assets are of short duration -- under the amended rules, the weighted average maturity of a fund's portfolio of securities can't be more than 60 days, down from 90 days previously -- the amortized cost price and the mark-to-market price (the shadow price) are identical to the penny. The shadow price simply is a case of carrying the stable $1 NAV out more than two decimal places, to four, as required by the SEC starting in November. This shadow price might be $1.0001, for example, or $0.9999."
Cunningham continues, "Although the value of the money fund will end up being rounded to a dollar, we believe investors and the SEC should benefit from seeing the shadow price because it will provide statistical confirmation of the stability of a $1 NAV and -- as had been discussed but ultimately rejected by the SEC as part of the changes to Rule 2a-7 industry standards -- disprove the need for a floating NAV. For record-keeping, accounting and valuation purposes, $1 NAV pricing is critical to the nearly $3 trillion-asset money market industry, which is a key source of short-term funding for business and industry."
Finally, she says, "Moreover, shadow pricing of money market funds really isn't new. The industry currently has been providing shadow pricing of each fund to the SEC twice a year, but not in a way that was operationally identical from fund to fund. Now it will be reported in a standardized format. As such, the SEC -- and investors who care to do so -- will be able to collect the fund data over a period of time so that perhaps they can discern patterns among types of funds and groups over a period of time. And we think that will prove, on a quantitative basis, what we have been suggesting all along -- that when you look at the statistical evidence, there is no need to consider a fluctuating NAV."
