The Federal Reserve Bank of Boston's Supervisory Research and Analysis Unit recently posted an article entitled, "Swing Pricing Calibration: A Simple Thought Exercise Using ETF Pricing Dynamics to Infer Swing Factors for Mutual Funds." The paper explains, "In March 2020, amid the onset of the COVID-19 pandemic, pooled investment funds that invest substantially in short-term debt instruments experienced large net redemptions and runs. For example, in the two-week period ended March 24, 2020, net redemptions from publicly-offered institutional prime money market mutual funds (MMMFs) were about 30 percent (Presidents' Working Group on Financial Markets (PWG 2020)). Ultra-short-term bond mutual funds (MFs), including those that invest substantially in short-term corporate debt instruments, experienced large monthly net outflows of about 15 percent of net assets in March 2020. These outflows resulted in some funds liquidating their underlying assets at large discounts, which contributed to volatility in the prices of those assets and strains in broader financial markets."
It continues, "Policy makers are assessing potential options to reduce the structural vulnerabilities in MFs and MMMFs, particularly those that invest in assets that can suddenly become illiquid during periods of stress. One option under consideration is swing pricing, or the process of adjusting a MF's net asset value per share (NAV) to pass on the costs arising from its net purchase or redemption activity to the investors responsible for that activity. Swing pricing can disincentivize large redemptions; however, effective design and calibration require real-time estimates of liquidity costs. These liquidity costs can be difficult to measure for certain corporate debt instruments, such as commercial paper, which generally only have thin secondary markets, even during normal times."
The piece tells us, "In this note, we use pricing dynamics for Exchange-Traded Funds (ETFs) that invest primarily in short-term debt to provide rough estimates of a range of swing-factor-proxies for MFs that invest in similar assets. The premise underlying this thought exercise is that MFs and ETFs that hold similar portfolios are comparable, except for the fund structure. Accordingly, the magnitude of ETF premiums and discounts could be a useful, albeit imprecise, proxy for liquidity costs for a MF that holds similar assets to the ETF. Thus, for MFs that held at least 50 percent of their pre-COVID-19 net assets in short-term corporate debt, swing-factor-proxies (that is, the ETF price discount to the value of its underlying assets) ranged between 2 and 7 percent, on average, during the most stressful period in March 2020."
It continues, "This measure tended to be higher for MFs that held more short-term corporate debt than the median MF and those with a longer weighted average life (WAL) than the median MF. For MFs that invest at least 50 percent of their pre-COVID-19 net assets in government-related securities, the analogous range is only 0.01 percent to 0.11 percent, on average. These much lower ranges likely reflect the relatively low-risk and high liquidity of these funds' underlying assets."
The introduction adds, "Thus, during periods of stress in which funds experience large net redemptions, swing factors could range between 0.01 percent, for MFs that invest substantially in short-term government-related securities, to almost 7 percent for those that invest substantially in short-term corporate debt, on average. These proxies could be useful for benchmarking stress-period swing factors in which funds that invest substantially in money market instruments experience large net redemptions. Outside this cohort, the general framework could also be useful to benchmark swing-factor-proxies for other types of MFs that invest in less liquid assets, including municipal bonds, which also experienced unusually large net outflows in 2020."
The Boston Fed's conclusion comments, "Open-ended collective investment vehicles, particularly those that invest in non-government debt, engage in liquidity transformation. Large redemptions and runs from these vehicles can negatively impact financial markets, as was observed in March 2020. One potential policy option for dampening large redemptions and destabilizing runs on funds is swing pricing, particularly if it is designed so that redeeming shareholders bear the full costs of their redemption activity. Despite swing pricing's potential benefits, calibrating swing factors is difficult, particularly for assets with thin secondary markets, such as commercial paper."
Finally, it says, "In this note, we provide a framework that can be used to benchmark swing factors for different fund types. For example, for MFs that invest primarily in short-term corporate debt, the discount-to-NAV could fall between 2 percent to 7 percent, on average, during periods of stress in which the funds experience large net redemptions. Our analysis could be useful to policy makers that are examining methods to calibrate swing factors that reasonably approximate transaction costs, while preserving the benefits of the fund to investors."
In other news, the Investment Company Institute's latest weekly "Money Market Fund Assets" report shows assets falling $17.5 billion during the week including month-end, after a big jump (up $28.6B) the prior week. Assets fell sharply in the first three weeks of January (down $88.5B), which followed 8 straight weeks of gains at year end (up $150.6 billion). Year-to-date, MMFs are down by $77 billion, or -1.6%. Over the past 52 weeks, money fund assets have increased by $317 billion, or 7.3%, with Retail MMFs falling by $50 billion (-3.2%) and Inst MMFs rising by $366 billion (13.2%).
ICI's weekly release says, "Total money market fund assets decreased by $17.53 billion to $4.63 trillion for the week ended Wednesday, February 2, the Investment Company Institute reported today. Among taxable money market funds, government funds decreased by $18.65 billion and prime funds increased by $1.31 billion. Tax-exempt money market funds decreased by $194 million." ICI's stats show Institutional MMFs decreasing $14.9 billion and Retail MMFs decreasing $2.7 billion in the latest week. Total Government MMF assets, including Treasury funds, were $4.101 trillion (88.6% of all money funds), while Total Prime MMFs were $439.9 billion (9.5%). Tax Exempt MMFs totaled $86.4 billion (1.9%).
ICI explains, "Assets of retail money market funds decreased by $2.67 billion to $1.48 trillion. Among retail funds, government money market fund assets decreased by $1.94 billion to $1.20 trillion, prime money market fund assets decreased by $702 million to $201.11 billion, and tax-exempt fund assets decreased by $30 million to $76.77 billion." Retail assets account for just under a third of total assets, or 32.0%, and Government Retail assets make up 81.3% of all Retail MMFs.
They add, "Assets of institutional money market funds decreased by $14.86 billion to $3.15 trillion. Among institutional funds, government money market fund assets decreased by $16.71 billion to $2.90 trillion, prime money market fund assets increased by $2.01 billion to $238.74 billion, and tax-exempt fund assets decreased by $164 million to $9.64 billion." Institutional assets accounted for 68.0% of all MMF assets, with Government Institutional assets making up 92.1% of all Institutional MMF totals. (Note that ICI's asset totals don't include a number of funds tracked by the SEC and Crane Data, so they're almost $400 billion lower than Crane's asset series.)
