Fund companies continue to produce papers and briefs designed to educate their investors on the approaching changes to money market funds. Below, we excerpt and link to new pieces from Fidelity and BlackRock, and we also cite some recent comments on money funds from former Fed Chair Ben Bernanke. Fidelity Investments' latest commentary, entitled, "Data-Dependent Fed Holds Rates Steady," analyzes how much, or how little, money market fund NAVs will actually float (in addition to discussing rates). BlackRock's new white paper, "Insights to Act On: Adapting Cash Investment Policies for Money Market Reform," features a case study on how expanding the use of liquidity products can increase returns. Finally, Bernanke blogs, "What tools does the Fed have left? Part 1: Negative interest rates."
Fidelity's Michael Morin and Kerry Pope take a look at how much a floating NAV might float. They write, "By October 2016, institutional prime and institutional municipal MMFs will begin trading with variable net asset values. In line with SEC requirements, these MMFs will no longer use amortized cost accounting and will be priced and transacted with NAVs out to four decimal places -- commonly referred to as basis point rounding. As a step toward this change, institutional prime and institutional municipal MMFs are required to publish market-value NAVs beginning in April."
Fidelity's paper explains, "The same factors that can have the most impact on money market fund NAVs today -- interest rates, credit spreads, idiosyncratic issuer risk, realized gains and losses, and investor flows -- will continue to have the most influence on NAVs going forward. Today, however, small changes in the NAV -- less than $0.0050 -- do not impact the price at which investors buy and sell shares. Once institutional prime and institutional municipal MMFs begin to float their NAVs, a move of $.0001 (1 basis point) as a result of one or all of these factors, will result in an increase or decrease in the variable NAV -- an investor's transaction price."
It continues, "The timely example of the Federal Reserve's December 2015 interest-rate increase demonstrates how one of these factors could influence money market NAVs.... Looking at the universe of prime institutional MMFs as of September 30, 2015 -- prior to the Fed's rate move -- 85% of the funds had NAVs greater than $1.0000 per share. By December 31 -- after the 25 basis point increase in the fed funds rate -- only 25% of the funds had NAVs greater than $1.0000. One could theorize that the rate increase contributed to lower prices of fund holdings and thereby reduced NAVs."
Morin and Pope tell us, "This example demonstrates that as a result of variations in any of the factors listed earlier, a variable NAV can fluctuate and contribute to the dispersion of NAVs across the industry. Income is another important factor to consider. After the rate increase in this example, the income earned by the fund would likely have risen. This highlights the significance of total-return calculations in cash management."
Finally, they conclude, "Increasingly, institutional investors are weighing the implications of the money market fund modifications coming later in 2016. This summary attempts to clarify one facet of the coming changes that investors are wondering about -- the implications of variable net asset values. While the concept seems straightforward on the surface, it has technical investment implications that require thorough consideration by investors. The key takeaways for investors in institutional prime and institutional municipal MMFs after October 14 are that 1) market-based NAVs will fluctuate, and 2) investors will have to change their analysis when considering an MMF transaction, by transitioning from a money-market-equivalent-yield perspective to a total-rate-of-return evaluation."
BlackRock's paper includes a case study that highlights the need to have an investment policy that includes a range of liquidity investments. It says, "If cash investors maintain restrictive investment policy language requiring money market funds to hold a constant net asset value (CNAV), we anticipate a sizeable shift by investors from Prime to Government MMFs in the U.S. If this shift in assets occurs, we expect the difference in yields between these strategies to widen, creating a greater opportunity cost to carrying liquidity in Government MMFs. This cost of liquidity underscores the importance of flexible, post-MMF reform investment policies. When combined with effective cash forecasting, tremendous value can be added to a cash portfolio."
BlackRock explains, "We present three scenarios, and assume the investor has a $100 million portfolio that requires 40% liquidity on a monthly basis, 30% liquidity semi-annually with the remaining 30% of the cash not needed for a period of greater than 12 months. Scenario 1: 100% Government Strategy: A 100% Government Strategy could generate an approximate yield of 0.03% based on the weighted average of the 30-Day SEC Yield for the period January 2015 to January 2016. Scenario 2: Government and Prime Strategies: If the portfolio is invested into this combination of products, the yield could increase to approximately 0.08%. In terms of real dollars, the income earned could increase from `$30,000 in Scenario 1 to $84,000 in Scenario 2. Scenario 3: With an Ultra-Short Duration Allocation: If the portfolio is invested into this combination of products, the yield could increase to approximately 0.14%. In terms of real dollars, the income earned could increase from $84,000 in Scenario 2 to $135,000 in Scenario 3.
It concludes, "Given the opportunity cost of complacency outlined in our case study, we expect that the changes to Securities and Exchange Commission registered MMFs will also expand the types of liquidity products investors will use going forward <b:>`_. These investments include direct securities, money market mutual funds, short duration mutual funds, Exchange Traded Funds (ETFs) and separate accounts. A powerful investment policy will allow for investments in those solutions that each company deems appropriate based on their risk profile and the investment objectives of each pool of cash. Specificity is critical and in the new world, distinction regarding money market fund vehicle requirements (CNAV vs. FNAV) is essential."
Bernanke writes in his piece, "There has been much discussion recently about negative rates' effects on bank profitability, but the 2010 Fed memo was more concerned about money market funds (MMFs), which play a larger role in the U.S. than in Europe or Japan. Like banks, U.S. MMFs have traditionally promised [sic] their investors the ability to withdraw at least the full amount that they've invested. Not making good on this promise is known as "breaking the buck." (When a fund did this in 2008 due to losses on its Lehman Brothers commercial paper, it started a highly destructive run on the fund industry.)"
He explains, "The Fed staff memo expressed concern that, facing zero or negative short-term interest rates, MMFs could break the buck or shut down as their management fees dried up. MMFs are important providers of short-term funding for both banks and nonfinancial firms; and, although in the long run the cash that flows through MMFs would find some other channel, in the short run a squeeze on MMFs could be disruptive."
Bernanke continues, "Events since the staff memo was written have reduced, but not eliminated, these concerns. MMFs used to be able to maintain the appearance of stability by displaying a constant net asset value of at least $1.00 per share, but Securities and Exchange Commission (SEC) reforms announced in 2014 (set to be fully implemented this October) have changed that. Starting in October, MMFs will have to display floating net asset values with four decimal places, except for government MMFs (funds with 99.5% or more of their holdings in cash or government securities) and prime funds focused on retail depositors (as opposed to institutional investors)."
He adds, "With floating net asset values, MMFs will no longer effectively be promising to pay investors back dollar for dollar, that is, "breaking the buck" is no longer an issue. However, as mentioned, not all funds must adopt the new approach; those that do not could still be potentially rendered unstable by consistently negative returns on the assets they hold.... The anxiety about negative interest rates seen recently in the media and in markets seems to me to be overdone."
