Capital Advisors Group published a paper entitled, "Demystifying Private Liquidity Funds," which reviews a recent SEC paper on Private Liquidity Funds and recent SEC Statistics on this over $500 billion and little noticed segment of the money markets. CAG's Lance Pan explains, "Important regulatory changes to institutional prime money market funds are forcing new ideas and new interest in prime fund alternatives. With the SEC Form PF aggregate data, we reconstructed a profile of unregistered private liquidity funds promising investors stable $1.00 NAVs without liquidity gates. We discuss the drawbacks with private funds as being unfamiliar to the institutional cash community, the mishap with a large fund during the financial crisis, the vulnerable liquidity model, the requirement for investor sophistication, poor transparency, the risk of liquidity lockups and share suspensions, and their uncertain future related to systemic concerns."
Regarding the "Potential Benefits to Institutional Cash Investors," Pan says, "With the cursory knowledge described above, one may deduce that private funds resemble money market funds but with less SEC oversight, more management flexibility, and perhaps a specialized shareholder makeup using the funds for special purposes.... At the risk of generalizing an asset class hidden from public view, we think private funds may be beneficial to institutional cash investors in the following respects."
These include: "Stable Net Asset Values: A private fund's ability to be free of the SEC's fair value pricing requirement, and instead valuing portfolio holdings at their amortized costs.... No Redemption Gates: This statement may be inaccurate as of June 2016, because the staff paper found 93% of the Section 3 funds could suspend redemptions and 80% had lock-up (gating) provisions.... Self-Reported Compliance with 2a-7: It is also possible that private funds targeting money market fund investors will claim partial compliance with Rule 2a-7, though they are not required to do so as unregistered funds.... [and] Manager Flexibility and Higher Yield Potential: Some private liquidity funds may appeal to certain investors interested in higher yield potential than in a regulated prime fund."
Among the "Risk Concerns," Pan cites: "A New Concept that Lacks a Following: Despite an established history in other segments of the investor base, private liquidity funds designed to circumvent certain Rule 2a-7 limitations are a relatively new phenomenon for corporate cash investors. Shareholder distribution as reported in the SEC statistics revealed virtually no participation by non-financial corporations, educational or municipal entities. Size may be another impediment, as we are not aware of any funds targeting corporate and municipal shareholders with assets greater than $1 billion, an important milestone to gain institutional following. Insufficient public data and an insufficient track record also add to the impediment."
He also lists: "Guilt by Association: Memory of the $34 billion Columbia Strategic Cash Portfolio, the poster child for a private liquidity fund gone bad, is still fresh in the minds of many a decade after the fund's demise. While some are quick to set apart today's private funds from their "ancient" brethren, the funds' legal structures, regulatory framework (other than Form PF) and shareholder concerns have not changed much. Complex Legal Structure: Private funds are not for everyone, legally at least. The SEC limits shareholders in private funds exempt under Section 3(c)1 of the Investment Company Act [or] Section 3(c)(7).... Such complexities often result in offering documents for supposedly simple liquidity products that are several hundred pages long."
Capital Advisors also mentions as risks: "Investor Sophistication; A Vulnerable Liquidity Model: Our main reservation towards private funds is our understanding of the "public liquidity in a private fund" model, which may be incompatible with some investors.... A Step Back in Transparency: The lack of portfolio transparency may lead shareholders to redeem shares indiscriminately first and ask questions later in times of uncertainty, as they did in 2008.... Risk of Suspended Redemptions and Gates: It may be unfortunate for investors fleeing redemption gates in prime funds only to be met by lockups (gates) or suspended redemptions in private funds.... Faced with the two choices, we think investors may be better off with the 2a-7 gate where, if a fund board chooses to impose one, the SEC allows the gate to be in place no longer than 10 business days in a 90-day period."
The Capital Advisors piece concludes, "Important regulatory changes to institutional prime money market funds are forcing new ideas and new interest in prime fund alternatives. One such alternative is private liquidity funds, for which the SEC has disclosed some aggregate level information from the Form PF filing. The private liquidity funds relevant to institutional cash investors are unregistered private assets pools, legally available only to sophisticated investors, that seek to maintain $1.00 stable NAV but without liquidity gates, that may pledge some level of compliance with Rule 2a-7. Other than the NAV and gates characteristics and the exemption from SEC registration, the private funds have the look and feel of regular money market funds."
They add, "We discussed several potential drawbacks with private funds as being unfamiliar to the institutional cash community, the mishap with a large fund during the financial crisis, the vulnerable liquidity model, the requirement for investor sophistication, poor transparency, the risk of liquidity lockups and share suspensions, and their uncertainty related to systemic concerns. We recognize the merit of private liquidity funds for certain sophisticated investors in special circumstances. While much remains to be learned of this revamped product, we caution the general treasury management community against plunging in before fully understanding the legal complexity and liquidity risk profile."
The SEC's paper, "`Private Liquidity Funds: Characteristics and Risk Indicators," written by Daniel Hiltgen, says in its "Abstract," "At the end of 2015, $534 billion in assets were held by private liquidity funds or managed in their parallel accounts that follow similar investment mandates as money market mutual funds (MMFs), but are unregistered. Limited information is publically available about these funds that are in AUM terms roughly a quarter of the size of institutional MMFs. This white paper characterizes these private liquidity funds using data from Form PF and compares them to MMFs."
Finally, the SEC's "Private Funds Statistics, Second Calendar Quarter 2016" says, "This report provides a summary of recent private fund industry statistics and trends, reflecting data collected through Form PF and Form ADV filings <b:>`_. Form PF information provided in this report is aggregated, rounded, and/or masked to avoid potential disclosure of proprietary information of individual Form PF filers." (Editor's Note: Crane Data believes that the vast majority of these assets are securities lending reinvestment cash, and that these "private liquidity funds" are not the same as some new ones that are being marketed to corporate investors.)
