Standard & Poor's released a "Credit FAQ" entitled, "Shedding Light On The 'Shadow' Net Asset Value Of Money Market Funds." The piece, written by Analysts Ruth Shaw and Jaime Gitler, says, "Many investors believe that a money market fund's net asset value (NAV) never deviates from $1.00 per share. They perhaps come to this conclusion because in the money fund industry's 40-year history, with two exceptions, shareholders have redeemed their shares at exactly $1.00. Also, when investors view the $1.00 price per share on their statements, it reinforces the misconception about a fund's NAV."
It continues, "The reality, however, is that a fund's marked-to-market NAV changes constantly, every day, and ranges from $0.9950 to $1.0050. This tight band of variation, when rounded either up or down to two decimals, equals $1.00. It's important to remember that many elements influence a fund's NAV and cause its fluctuation, such as shifts in interest rates, credit spreads, and shareholder activity."
S&P explains, "Given the volatility in the money market industry over the past two years, the Securities and Exchange Commission (SEC) recently revised its guidelines for registered U.S. money market funds. On Feb. 23, 2010, the SEC released final amendments to Rule 2a-7, which governs registered money market funds under the Investment Company Act of 1940. In this release, the SEC focused on three key areas in its regulation of funds: liquidity, credit quality, and operational procedures. Their goal is to reduce investment risk of registered money market funds."
They say, "The SEC is now requiring fund companies to post their portfolio holdings as well as a variety of statistics on their own Web site each month. Also, they must submit detailed monthly holding reports and fund-level statistics to the SEC through Form N-MFP, which will then appear on the commission's Web site. In addition to statistics such as a fund's weighted average maturity, individual security information, maturity dates, CUSIPs, and security types, funds must now also disclose the "shadow" NAV -- the true (nonrounded) marked-to-market NAV per share out to four decimals. Unless the fund is invested 100% in securities that mature overnight where the reported NAV will be exactly $1.0000, in the vast majority of instances, these funds will report a number between $0.9950 and $1.0050. Fund companies will first have to submit these new disclosure requirements to the SEC on Dec. 7, 2010, and then the postings will be available on the SEC's Web site with a 60–day delay."
Shaw and Gitler write, "Fund managers are concerned about shareholder reaction to viewing the marked-to-marked NAV on the SEC's Web site. Will shareholders withdraw their investment if the fund is priced at less than $1.0000? Will they invest more money into a money market fund with an NAV that's higher than $1.0000 to try to make small gains? Despite the concern in the market, Standard & Poor's Ratings Services believes there's no cause for alarm. Below, we answer some frequently asked questions about shadow NAVs in money market funds."
Among the "Frequently Asked Questions, the article asks, "How do funds calculate their NAV?" It answers, "A fund's marked-to-market NAV, also known as its price per share, or "shadow" NAV, is determined by dividing the total value of all the investments in its portfolio, minus any liabilities, by the number of fund shares outstanding. This marked-to-market calculation stems from the true market value of a fund's assets, rather than "amortized cost" NAV. The amortized cost method of pricing permits money funds to price their securities by amortizing any discount or premium in the purchase price straight to its maturity.... Standard & Poor's requests that our rated money market funds calculate and report to us at least weekly the shadow NAV per share using marked-to-market prices with NAVs rounded to at least five decimals."
It also asks, "What factors cause a fund's NAV to fluctuate?" S&P answers, "A money market fund's shadow NAV will change due to the pricing of underlying securities in a fund's portfolio, shifts in interest rates, and the flow of money into and out of a fund. For example, if the Federal Reserve raises or lowers interest rates, the Treasury market rallies, or a downgrade or upgrade of a particular security occurs, a fund's shadow NAV may react. Shareholder redemptions and subscriptions can also greatly magnify those factors on a fund's marked-to-market NAV. Because money funds issue and redeem shares at $1.0000, provided that their market value is between $0.9950 and $1.0050, funds can pay out $1.0000 on shares that may actually be worth as little as $0.9950. When a fund redeems or pays out $1.0000 on shares that are worth less, the redeeming shareholders dilute the remaining assets for the remaining shareholders. This dilution will exacerbate any realized or unrealized losses that exist in the fund."
Finally, they ask, "How will investors react to shadow NAVs posted on the SEC's Web site?" The piece responds, "It's difficult to know how investors will react when they see a marked-to-market NAV on the SEC's Web site that is less than $1.0000. As we approach the Dec. 7, 2010, deadline for fund companies to submit these marked-to-market NAVs to the SEC for public disclosure, we've seen instances in which fund sponsors have chosen to put money into their funds to boost their NAVs above $1.0000. It appears fund managers are concerned that investors may pull out of their money market funds if they see anything less than $1.0000 on the SEC's site. However, it's important for investors to know that the numbers will be reported on a 60-day lag and that the current marked-to-market NAV could be different from what is reported. In addition, investors should be aware that funds whose NAVs have small deviations, either above or below $1.0000, are common and expected given unrealized or realized gains and losses in the funds, and changing interest rates. For the past 25 years, we have seen these deviations daily by tracking the marked-to-market NAVs of our rated money market funds out to five decimal places, and we expect slight fluctuations around $1.0000. These slight deviations are no cause for alarm."
