The latest "Arrowhead Weekly" update, published by Denver-based Arrowhead Credit Research Corp., features an interesting discussion on the debate over a floating NAV money fund in "To Float Or Not To Float: Is That Really The Question?" Director of Research Barry Weiss writes, "A more relevant connection to the headline this week has to do with the public debate occurring in money market land, as to the appropriateness of a floating NAV for a money fund. This past week we saw an article from Ignites, reporting on the launching of a floating NAV money market fund from DB Advisors, and CraneData re-ran a previously published article by BlackRock which had laid out the reasons against a floating NAV money fund. Generally, the points in both articles are well made, but I'm more surprised at how emotional the topic has become."
He explains, "There are more than enough these days written about the importance of the money fund in the mechanisms of the capital markets. Certainly the case has been made repeatedly on how issuers rely on this $2.0 trillion plus industry to help fund themselves via cheaper short-term debt instruments. Putting Paul Volcker aside, I don't think anyone truly doubts that money funds are a necessary cog. But during discussions on regulatory reforms and wrist-slapping in the form of more onerous oversight and structure, there was a point where the idea of a floating NAV fund came to the forefront. Stable value ended up winning the day, but it did signify that ideas that were a few steps forward in the evolution of money funds were being considered. And that was surprising, given the industry's aversion to change."
Arrowhead says, "I don't think there has ever been a point where a change in any industry, company or even in our own personal appearances such as a hair style has been truly embraced from the get go. But here, in terms of a floating NAV fund, there is certainly a more emotionally charged refusal to embrace it than most would have guessed. In the past, one of our concerns had been that once a fund or a few funds were launched and there is some acceptance, regulators would use that small sampling to hammer home their final piece of operational requirements. The launching of the fund with some publicity for DB Advisors with a proposed initial NAV of $10.00 certainly makes that seemingly possible."
But the piece continues, "Supposedly one of the main advantages of a floating NAV is that its transparency would limit the possibility of a run on the fund. The idea is shareholders will get used to the fluctuating NAV and thus, as it rises and drops with the tide of the credit markets, they will merely shrug it off. That may be so when it comes to retail shareholders. But the systemic risk in money funds all along has not been retail, which generally are pretty sticky assets, it is institutional. Corporate treasurers, prior to the meltdown, were notorious 'click and invest' types, many of them using portals which allowed them to move larger sums of monies on a daily basis. At that time, it was mostly yield that caused them to move the money. The complexes that saw vast outflows during troubled times were mostly ones that had come to rely on that type of investing to capture the assets to begin with."
Weiss tells us, One of the points of the Ignites article was that the floating NAV fund should be able to capture a bit more yield, and if that is truly so, I would assume it would initially attract the same type of investor that previously spent their mornings searching for yield. But given the willingness to move quickly into the fund for that reason, as we have already seen, that type of investor would almost assuredly run for the exits if the fund dropped below the initial NAV. Those types of investors and the trades they initiated were not built on relationships; it was built on yield hunting. Dropping below par, no matter what form it looks like, isn't going to keep them from clicking their assets away."
Arrowhead says, "The cash management sector is notorious for being nervous and quick to exit. And if the managers of funds react in that manner, it is hard for me to understand why one would expect shareholders in those funds to act differently. Regardless of structure, floating NAV or stable value, at the end of the day, no one wants to risk their job on a being patient while their balance drops below par. Certainly a corporate treasurer is not willing to risk his or her job in the hopes the NAV will float back above initial investment. Time is not on the fund's side in this case, and my expectation would be that the treasurer would pull his monies out at the moment he thinks he won't get principal back."
Finally, the piece warns, "Stable value funds have another problem: it is becoming dominated by larger and larger companies.... That is also a sign the funds that remain are now being run by stronger, perhaps better staffed entities, and those that during darker times had sponsors that stepped up and supported funds that needed capital infusions or credit support. That is good from the standpoint of shareholders, retail or institutional, looking for a strong support history and creditworthy sponsor. However, the dominance of the stronger sponsors also creates a conundrum in that ultimately their success in capturing assets creates a dangerous lack of investor diversity. That is a problem at the sponsor level, as the size of a future bailout could prove to be too large for even the strongest sponsors, but even more so for issuers.... In essence, their size and dominance in the market and the turning the spigot off could not only threaten their own survival; but, also squeeze and threaten the issuers themselves."
