Money market funds used to be an afterthought. An investment vehicle that paid nice interest, (remember 5% back in 2007?), with funds available on demand, and mostly used in place of savings accounts. Fast forward to September 2008, the collapse of Lehman Brothers resulted in a default on its debt. One money market fund, the Reserve Fund, which had just over 1% of assets invested in short-term debt issued by Lehman Brothers, ‘broke the buck’ and went under the $1 net asset value money markets trade, in turn causing a run of redemptions at it and other funds.
The SEC sought to prevent this modern day bank run from happening again, implementing a series of temporary fund guarantees that lapsed over the last few years in addition to restricting the securities money market funds could purchase. But just passed last week by a 3-2 vote, was a rule affecting prime institutional money funds. Prime money funds invest in securities issued by U.S. and foreign entities ranging from corporations, financial institutions, the U.S. government, and government sponsored entities. Now, prime institutional money market funds:
- Are required to have a floating net asset value (NAV)
- Will give fund boards the option to impose liquidity fees and redemption gates if the funds “weekly liquid assets” fall below a threshold.
From our conversations with portfolio managers of money market funds, the legislation was designed to not harm individual investors, hence money market funds held by “natural persons” will not likely be subject to the rules, depending on interpretation by the fund companies (which is ongoing). There could be future changes to the rules and retail funds, so the initial rule adoptions are important to follow, not only to better understand the rules around what investors own, but also for the shortcomings of the rules themselves. SEC Commissioner Kara Stein noted in her statement what could happen if part two of the final rule is instituted (such as 1% to 2% redemption fees and restrictions on redemptions):
“…after careful study, I am concerned that gates are the wrong tool to address this risk. As the chance that a gate will be imposed increases, investors will have a strong incentive to rush to redeem ahead of others to avoid the uncertainty of losing access to their capital. More importantly, a run in one fund could incite a system-wide run because investors in other funds likely will fear that they also will impose gates. I share the concerns of many commenters and economists that while a gate may be good for one fund because it stops a run in that fund, it could be very damaging to the financial system as a whole.”
While money market funds have two years to comply with the new rules, we recently spoke with the head of money markets at Schwab Investment Management to better understand how our clients may be affected. As the situation continues to unfold, we will provide further updates. Please let us know if you have any questions in the interim.
For more information, please contact Aurum Wealth Management Group at 440-605-1900 or visit our website at aurumwealth.com. To stay up to date with the latest investment-related news, follow us on Twitter @aurumwealth and sign up to receive our free newsletter.
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