On Tuesday, the Investment Company Institute hosted a webinar entitled, "Stable NAVs and Shadow Prices of U.S. Money Market Funds and published a press release entitlted, "Money Market Funds' "Shadow Prices" Fluctuate Regularly; Historical Data Show Limited Movement A Variety of Factors Can Affect Funds' Portfolios." Both discuss a new paper from the mutual fund trade group entitled, "Pricing of U.S. Money Market Funds," which discusses the history of "shadow" pricing and the factors behind the (usually) minor deviations underneath the funds' stable $1.00 per share prices and which attempts to educate investors and fund professionals on the pending Jan. 31 disclosure of money funds' shadow NAVs.
ICI's release says, "Forthcoming disclosures are likely to increase investors' awareness of money market funds' portfolios and pricing. To help investors understand these disclosures, a new research report by ICI, "Pricing of U.S. Money Market Funds", conducts economic analysis and examines historical data on funds' per-share market value, known as the 'shadow price.' The ability to offer shares at a stable $1.00 net asset value (NAV) is a core feature of money market funds. Under securities laws, a money market fund can offer shares at a stable $1.00 NAV as long as its per-share market value, also known as its 'shadow price,' stays within a range of one-half cent of $1.00—between $0.9950 and $1.0050."
It explains, "The report finds that events large enough to move per-share market values by $0.0050 are extremely rare. The report's economic analysis shows that four factors likely to change a fund's market value are falling or rising interest rates, a `portfolio's dollar-weighted average maturity, investors selling or purchasing shares, and a credit event, such as a ratings upgrade or downgrade or a default, affecting a security in the fund's portfolio. The report's examination of historical data finds that money market funds' shadow prices did fluctuate during the past decade, but that the changes were within a narrow range. Analyzing a sample of prime money market funds holding one-quarter of industry assets, the report finds that the funds' average per-share market value moved between $0.9980 and $1.0020 during the decade from 2000 to 2010, a period when the financial markets experienced wide variations in interest rates and asset prices."
Chief Economist Brian Reid comments, "Money market funds' per-share market values can and do deviate from $1.0000, but these changes are typically small. Money market funds hold high-quality, short-term securities and manage their portfolios to limit interest rate risk, credit risk, and liquidity risk. These factors help to limit the movements in funds' shadow prices."
ICI's release continues, "Money market funds have routinely calculated per-share market values for decades and disclosed them in semi-annual reports. These values are called shadow prices because they typically very closely track or 'shadow' the stable $1.00 net asset value that money market funds seek to maintain. Nevertheless, for many investors, their first exposure to money market funds' per-share market values will be on January 31, when the Securities and Exchange Commission will publish a snapshot of funds' shadow prices from November 30. The new monthly disclosure is required by the Securities and Exchange Commission's amendments in January 2010 to Rule 2a-7, the regulation that governs money market funds and sets the structure that allows them to offer a stable $1.00 NAV."
ICI President Paul Schott Stevens says, "Money market funds are even better positioned today than they were two years ago to handle stressful market developments. This is because the amendments to Rule 2a-7 strengthened money market funds by raising standards for credit quality, liquidity, and maturity. While regulations and portfolio management limit funds' risk, investors need to understand that money market funds are not guaranteed, as is fully disclosed in every money market fund prospectus. We hope that the public release of shadow pricing data will remind the public of that fact."
They also say, "ICI research finds that large, sudden changes in market conditions are necessary before a money market fund's market value would change by as much as $0.0050 and force the fund to consider whether to reprice its shares to less or more than $1.00 per share -- a development known as 'breaking the dollar' or 'breaking the buck.' ICI modeling, based on reasonable assumptions about money market funds' portfolio composition and maturity, finds that: Short-term interest rates must rise by more than 300 basis points (3 percentage points) in one day, absent any other changes in market conditions, to reduce a fund's per-share market value to $0.9950. Investor net redemptions must reach 80 percent of a fund's assets to reduce a fund's shadow price to $0.9950, absent any other changes in market conditions, and given an initial shadow price of $0.9990. A 100 basis point (1 percentage point) increase in interest rates combined with investor redemptions of 70 percent of a fund's assets would be necessary to reduce a fund's shadow price to $0.9950."
Finally, ICI writes, "Average shadow prices for prime money market funds in the sample -- those taxable funds that invest in corporate securities as well as government securities -- varied between $1.0020 and $0.9980 during the decade from 2000 to 2010.... Experience during the 2008 financial crisis demonstrates that `money market funds' shadow prices did not provide early warning of severe financial shocks. In the week ending September 10, 2008 -- two business days before the failure of Lehman Brothers -- 90 percent of prime money market funds in the sample had per-share market values within 5 basis points of $1.0000 (between $0.9996 and $1.0005). Even the following week, after Lehman Brothers had failed, 93 percent of prime funds in the sample had per-share market values greater than $0.9975, and none had a shadow price within 10 basis points of $0.9950."
