Fidelity Investments published, "Prime Fund Considerations in a VNAV World," a white paper that reviews the "yield differential between prime and government funds, net asset value (NAV) volatility, total rate of return perspective, size of prime money market funds, and the importance of liquidity risk management." The piece explains, "Money market regulatory changes have made the liquidity management environment more complicated for corporate treasurers. This paper examines several important prime money market fund characteristics that institutional investors should consider when contemplating a move back to prime funds in an effort to optimize their cash segmentation strategy."

The paper tells us, "On October 14, 2016, the money market industry pivoted to accommodate a new regulatory landscape that brought about variable net asset values (VNAV) for institutional prime money market funds (MMFs). At that time, many institutional investors demonstrated their preference for a constant net asset value (CNAV) by reallocating their investments from prime funds to government funds that retained the CNAV and were not subject to the potential liquidity fees and/or redemption gates.... Now that the one-year anniversary of the new regulations has passed, many institutional investors are reviewing their cash segmentation strategy to determine the appropriateness of prime money market funds amongst a broader set of potential investment solutions. These alternatives include bank deposits, government MMFs, and other solutions, such as ultra-short bond funds, separately managed accounts, and private placements."

It says, "Many institutional prime investors indicated their desire to remain in prime funds through the October 14, 2016, conversion deadline. However, as the deadline approached, most prime investors were unwilling to underwrite the operational risk and the uncertainty of future NAV volatility for the diminishing yield advantage of prime funds.... Utilizing the 7-day yield for institutional prime and government money market funds as reported below by iMoneyNet, one can see that the average yield differential has increased dramatically from both the pre-conversion and long-term average to reach in excess of 25 basis points."

Fidelity writes, "In our discussion with institutional clients, there does not appear to be any magic yield differential that could lead to a massive transition back to prime funds. In fact, some clients have indicated that no amount of yield pickup may entice them to leave the comfort of the $1.00 CNAV of government money market funds and subject their liquidity to potential fees and/or redemption gates. However, the majority of clients have recognized that the potential to increase returns by more than 25 basis points is worthy of further analysis.... Assets under management in institutional prime money market funds have increased by almost 46% since the beginning of the year ... indicating that for some investors the yield advantage is too much to pass up."

They continue, "One concern for institutional prime investors is a fluctuating NAV, which could lead to the redemption NAV being higher/lower than the subscription NAV, resulting in a gain/loss. Fidelity examined the historical 4-decimal daily market value NAV for Fidelity Investments Prime Money Market (FIPXX) from January 2011 through October 2017. The NAV was unchanged from the prior day 93.4% of the time. Since the industry conversion deadline to a VNAV on October 14, 2016, FIPXX has been unchanged 96.8% of the time and has ranged from $1.0003 to $1.0005. This recent period includes three increases of one-quarter percentage point each to the federal funds target rate range, and reinforced the fact that modest changes in the federal funds target rate may only have a minimal impact on the money market fund's NAV."

Fidelity also comments, "The VNAV aspect of institutional prime money market funds requires investors to shift from their historical money market equivalent yield calculation to a total rate of return perspective. While investors may welcome investment gains from NAV appreciation, they would prefer not to realize an investment loss as a result of NAV declines. As mentioned previously, the NAV for institutional prime funds has thus far exhibited limited volatility in terms of both frequency and magnitude of variability."

They state, "The VNAV construct of institutional prime money market funds may lead to investors realizing gains and/or losses due to the variable NAV and the typical frequency of trading in and out of the fund. Investors need to understand the tax implications of such activity and should consult their tax department for appropriate advice."

The update tells us, "While it was not uncommon to see institutional prime portfolios with assets in excess of $40 billion and more than a dozen larger than $10 billion prior to the conversion, there are only 6 institutional prime funds with more than $5 billion in the third quarter. The reduced size of the funds creates a challenge to large investors who typically have fund concentration limits and minimum fund size written into their investment policies. Investors with a $10 billion minimum portfolio size could be limited to just 3 institutional prime funds, while a 2.5% portfolio concentration could limit investment to as little as $300 million."

It adds, "As investors contemplate returning to institutional prime MMFs, they need to understand the risk of potential redemption gates and/or liquidity fees. In the event the weekly liquidity of a prime MMF falls below the minimum 30 percent of total assets (as defined by the SEC in Rule 2a-7), the fund's board of trustees may impose a liquidity fee of up to 2 percent on the redemption amount, or prevent redemptions altogether by imposing a redemption gate that can be in place no longer than 10 business days.... Since liquidity fees and redemption gates can occur if a fund's weekly liquidity falls below the 30% threshold, investors should consider the manager's approach to liquidity risk management when selecting a prime fund."

Fidelity states, "Since October 2016, the weekly liquidity of Fidelity Investments Prime fund (FIPXX) has not fallen below 50% of total assets and year-to-date is significantly and consistently higher on average than the industry's other large prime institutional funds. For investors who decide a prime money market fund may be an optimal solution for some portion of their liquidity needs, it may be useful to analyze the specific funds to identify the manager's ability to minimize volatility of both the NAV and weekly liquidity.... Institutional prime funds exhibiting high levels of weekly liquidity and low volatility of NAV and weekly liquidity may be worthy of consideration for institutional investors who have determined that prime money market funds are an appropriate means to enhance their total rate of return on strategic liquidity."

Finally, they write, "Optimizing corporate liquidity has become more complicated following the regulatory changes to money market funds. Accurate cash forecasting remains a critical process that enables the treasury team to appropriately segment their cash between operating and strategic components. The potential solution set has expanded following money market reform, and the fundamental characteristics of prime funds have been altered, requiring additional monitoring and due diligence. While a return to institutional prime money market funds may not be appropriate for every corporate treasurer, those with a thorough understanding of the risks and rewards may view variable NAV prime funds as a valuable component of their cash segmentation strategy (if permitted by investment policy)."

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