The very definition of a money market fund – maintaining a NAV of $1 a share – may change, but all for good reason. The Securities and Exchange Commission is expected vote on Jul 23 on a plan that would require prime money market funds to float the value of their shares. If the five-member commission on July 23 votes for the plan, the institutional funds would float the value of their share price and thus deviate from the age-old $1 a share rule. The plan also includes imposing a withdrawal fee.
The plan, issued last year, is aimed at restricting investors from fleeing the $2.6 trillion money funds industry during a financial stress period. The stampede out of the money funds in 2008 had threatened to froze up corporate lending; requiring the government to step in and put itself on the hook for roughly $1.6 trillion in corporate and municipal debt.
The institutional funds, accounting for 37% of the industry, will be directly affected rather than retail investors. The floating share prices apply to only prime institutional funds. The ruling will not affect retail funds or the ones investing in domestic government and municipal securities.
What are Money Market Funds?
Simply said, it is a form of investment whose motive is to earn interest and retain a net asset value (NAV) of $1 per share. This type of mutual fund is generally low-risk, low-return investment. Thus, money market funds are generally not a long-term investment option. The portfolio usually comprises short-term high-quality, liquid debt securities or monetary instruments. The cash-like instruments, money market funds, are preferred by millions of investors as a safe place to park their cash.
Reserve Primary Fund “Broke the Buck”
On Sep 16, 2008, The Reserve Primary Fund had “broke the buck” as its NAV dropped to 97 cents a share. For the first time in history a money market fund failed to retain a $1 a share NAV, causing widespread ripples in the industry.
The collapse of the $62.5 billion Reserve Primary Fund was due to its exposure to the bankrupt Lehman Brothers Holdings Inc.’s debts. At the time of the collapse, Lehman Brothers-issued short-term loans worth $785 million with the Reserve Primary Fund. Anticipation of losses on the holdings of Lehman commercial paper sparked concerns among investors, making them jittery about the value of the fund's other holdings. The fund value slumped as investors took money out of the fund, eventually compelling the Reserve Fund to suspend operations and commence liquidation. Investors eventually recovered around 99 cents on the dollar.
Congress set up the Financial Stability Oversight Council, following the financial crisis. The council which is a collection of regulators, then blamed the money market funds for playing a role in the recession.
A SEC staff in a report to the SEC commissioners noted:
“Investors began selling prime money market funds [those MMFs that invested in prime quality private securities] on Friday, September 12th, ahead of Lehman Brothers' bankruptcy on Monday, September 15th. They continued to sell prime money market funds on Monday, September 15th. ...At the same time, investors began buying government money market funds, which include Treasury and government funds. During the Crisis Month (9/2/2008 to 10/7/2008), government money market fund assets increased by $409 billion (44 percent), whereas prime fund assets fell by $498 billion (24 percent).”
The $1 Per Share Price
SEC permits the money market funds to use amortized cost accounting for reporting the NAVs of their portfolios daily. The money market funds can therefore offer and redeem shares at the fixed $1 a share price.
With the disappearance of the fixed $1 a share rule, money market funds will need to disclose fluctuations in the asset value after the closing bell on daily basis. The stable $1 per share NAV does not generate profits or losses. However, the floating price will enable investors to gauge their gains and losses for tax reporting.
Vote on July 23
The SEC has been under pressure from the US and global regulators and the Federal Reserve to cease the ruling. No one wants a recap of the 2008 financial crisis and the almost stampede out of money market funds. Federal Reserve Chairwoman Janet Yellen had commented recently that the rate of implementing more rigid rules for short-term funding markets “has, at times, been frustratingly slow”. That definitely puts SEC Chairman Mary Jo White on her toes to adopt the necessary rulings.
Reuters reported that a person familiar with the matter has confirmed SEC planning to conduct a vote on Jul 23 – where two provisions may be adopted as rule. The provisions are taking away the $1 a share rule and imposing withdrawal fees. Investors may also be temporarily blocked from escaping these funds during a financial stress period.
Republican Member of SEC Casts Doubt
The plan is expected to be favored by most of the five commissioners. Reportedly, Democrat Luis Aguilar and Republican Daniel Gallagher are in favor of the plan.
However a recent Reuters report notes that Republican member of the SEC Michael Piwowar said that there is “question on whether we are going to move forward on a floating (net asset value)”. He said he does not support the plan in the current form as floating shares must be rounded to the fourth decimal place. “We don't require that on any other mutual fund. It makes absolutely no sense to me”, said Piwowar.
He said the ruling “may” or “may not” have the floating NAV. He stated: “We are still in discussions. ... The commission is still trying to work to formulate what the final version of the rule will be”.
If You Want to Exit Now: Buy Government Bond Funds
Last time investors fled the money market funds and instead bought Treasury and government funds. If investors are eager to buy government funds now, we will pick 3 top-ranked government funds.
Below we will share with you 3 top-ranked Government funds. Each has earned a Zacks Mutual Fund Rank #1 (Strong Buy) as we expect the funds to outperform its peers in the future. Remember, the goal of the Zacks Mutual Fund Rank is to guide investors to identify potential winners and losers. Unlike most of the fund-rating systems, the Zacks Mutual Fund Rank is not just focused on past performance, but the likely future success of the fund.
Conservative investors prefer debt instruments not only because they safeguard the capital invested but also for the regular income flows they provide. Bonds bring a great deal of stability to an equity-heavy portfolio while providing dividends more frequently than individual bonds. U.S government bonds funds usually invest in Treasury bills, notes and securities issued by government agencies. They are considered to be the safest in the bond fund category and are ideal options for the risk-averse investor.
Apart from carrying a Zacks Mutual Fund Rank #1 (Strong Buy), the funds listed below also have positive year-to-date and one-year returns, low expense ratio and decent yields.
Fidelity Spartan Long-Term Treasury Bond Index Investor (FLBIX - MF report) seeks high current income by investing most of its assets in companies listed in Barclays U.S. Long Treasury Bond Index. The fund maintains a dollar-weighted average maturity of at least 10 years. The fund tries to duplicate the Barclays U.S. Long Treasury Bond Index returns by using statistical sampling techniques on the back of interest rate sensitivity and maturity among others.
The fund has returned 13.8% year to date and 8.2% over the last one-year period. The fund has an expense ratio of 0.20% as compared to category average of 0.56%. The fund also has a dividend yield of 3.09%.
Vanguard Long-Term Treasury Fund Investor Shares (VUSTX - MF report) was incepted in May 1986 and is managed by the Vanguard Group. It aims to provide high level of current income and preserve investors' principal. A large chunk of the fund’s assets is invested in U.S. Treasury securities or long-term bonds whose interest and principal payments are backed by the full faith and credit of the U.S. government. The fund maintains a dollar-weighted average maturity of between 15 and 30 years. Dividends are declared daily and distributed monthly.
The fund has returned 13.9% year to date and 8.3% over the last one-year period. The fund has an expense ratio of 0.20% as compared to category average of 0.56%. The fund also has a dividend yield of 2.97%.
Schwab Treasury Inflation Protected Securities Index (SWRSX - MF report) seeks to track the price and yield performance of the Barclays U.S. Treasury Inflation Protected Securities (TIPS) Index (Series-L) SM, excluding fees and expenses. The fund invests majority of its assets in companies included in this index. The index lists investment-grade publicly-issued TIPS with maturity remaining of at least a year. These securities need to have a minimum of $250 outstanding face value.
The fund has returned 6.0% year to date and 3.4% over the last one-year period. The fund has an expense ratio of 0.19% as compared to category average of 0.79%. The fund also has a dividend yield of 1.88%.
To view the Zacks Rank and past performance of all Zacks #1 ranked mutual funds, investors can click here to see the complete list of funds.
About Zacks Mutual Fund Rank
By applying the Zacks Rank to mutual funds, investors can find funds that not only outpaced the market in the past but are also expected to outperform going forward. Learn more about the Zacks Mutual Fund Rank at http://www.zacks.com/funds.