Content provided by Marc Pfeffer, Senior Portfolio Manager
Money market funds have been around since the 1970s. They have been a primary tool and source of liquidity for both retail and institutional investors for more than 40 years and have trillions of dollars of cash invested in them. I helped create a money market fund in the mid-1990s that is now incorporated into the CLS lineup of mutual funds. The fund is run extremely conservatively as I believe investors shouldn’t take any credit risk with their money market funds.
Money market funds, which include prime funds that buy instruments, such as commercial paper, were doing well until 2008. Only once had a money market fund ever “broken the buck,” i.e., dropped below its $1 net asset value (NAV). Then, as many know, Lehman Brothers defaulted. With that crash, large money market funds did not infuse enough capital to ensure their $1 NAV, and they “broke the buck.” If they weren’t holding securities like commercial paper, there would have been no need to prop them up.
Since then, the Securities and Exchange Commission has made subtle changes to the NAV rules. Here’s what your clients should know. Mutual funds invest in short-term money market instruments like T-bills and commercial paper. Historically, they have kept their share prices at a constant $1 NAV, creating a false sense of security that they couldn’t lose value. These funds aren’t guaranteed by the government or anyone else, even if the underlying investments may be.
The latest SEC rules will distinguish between money market funds sold to institutions and those sold to retail investors. Going forward, prime funds will see their share price start to float, just as any mutual fund’s price would. CLS’s Milestone Treasury Obligation Fund will not be subject to this restriction as it invests in government securities not impacted by this rule.
In addition, prime funds (and tax-free funds) will be able to limit big redemptions in times of stress (like the Lehman collapse). First, they can impose an exit fee of up to 2% for a limited time, and second, they can suspend redemptions for up to 10 days. This is on top of rules put in place over the past few years to shore up liquidity within these funds.
Investors will have to decide if it’s worth the extra risk to achieve a high yield on a prime fund versus a government fund. Several large money market funds have converted from prime to funds more comparable to the Milestone Fund. Please check with your own fund provider to ensure you understand how your money will be invested after the rules are in place and you have the comfort you need to stay invested.
Thanks for reading.