Scalper1 News
Summary Prime money market funds are going to be reporting their net asset values on a floating basis due to recent SEC rules. The effect will be to render these funds costlier, both on an accounting and a tax basis, and might lead to an outflow from these funds. However, the weighted average maturity of these funds, one measure of their riskiness, is well within SEC guidelines. The big, bad floating NAV is coming your way In 2014 the SEC adopted amendments to rules that govern certain types of money market funds. In particular prime money market funds – those that invest in corporate debt securities will have to report floating Net Asset Values (NAVs) instead of posting fixed NAVs as has hitherto been the case. Thus at any given time, capital appreciation or depreciation will have to be reported, leading to a move towards money market funds with a Treasury or municipal bond focus. Instead of assuming a fixed NAV of $1.00, investors will have to confirm the posted NAV price. There will also be liquidity management issues, since the use of these money market funds for intra-day liquidity management will be much diminished, given the uncertainties about the NAVs for these funds. Companies would have to monitor the marking-to-market value of these funds on their balance sheets. Finally, all sales of money market fund shares would become taxable events. Rule 2A-7 risk limiting provisions amended Traditionally SEC’s Rule 2A-7, adopted in 1983, allowed money market funds to use amortized cost to value the funds so long as they kept within very strict parameters. Since money market funds are not insured by the FDIC, they have traditionally had to keep within limits about the three primary risks they face. Of course, the first was interest risk, credit risk and liquidity risk (the risk that a borrower will not pay its obligations when due). Of course, the first two kinds of risks do not affect money market funds which invest in Treasuries or municipal bonds. But all three risks affect prime money market funds. With a fixed NAV based on amortized cost, investors did not need to track their capital gains and losses, since all of the return of a money market fund is paid out in dividends. In addition, a stable NAV allowed these funds to offer such services as check-writing and the other general features available to deposit accounts, while allowing investors to have access to some upside features. The daily dividend on the fund is based on the accrued interest based on amortized cost. At least that was the situation before the recent amendments by the SEC. On Weighted maturities and interest rate sensitivities. Given the above mentioned advantages of the stable NAV for money market funds, it was imperative to keep the funds within certain risk bounds. One way to do this was to limit the maximum weighted average maturity (WAM) of the funds. An increase in interest rates would decrease a fund’s shadow price. One measure of the sensitivity of any fund with respect to a change in interest rates is the fund’s weighted average maturity (the WAM). The WAM is the measure of the average maturity of the bonds in the fund’s portfolio, and the SEC rules provided that funds, in order to use amortized cost, could have a maximum WAM of 60 days. The higher the WAM, the more sensitive the shadow price of the fund would be to changes in interest rates. When redemption of funds is high, especially in times of crisis, (as was the case between 2007 and 2008), then shadow prices will fall below $1, and the WAM is especially helpful to understand the riskiness of these funds. Recent measures of WAM show relatively low riskiness. Money market funds are obligated to disclose their net assets, 7-day interest rates and WAMs on a monthly basis. Extracting some of this data from the SEC web site for four representative prime money market funds (those of BMO, BNY Mellon, Legg-Mason and Fidelity) show that all of these funds have WAMs well below 60 days. The shadow prices (not shown) are $1 for BMO and BNY Mellon, $1.002 for Fidelity and $1.0001 for Legg Mason in the period shown. Legg Mason, with a WAM over the period for its prime funds of 6 days, carries a 7-day rate on average of .23%. (The figures below come from the N-MFP disclosures on the SEC website). Does this mean there is no cause for concern? The above-mentioned trends do not mean that there is no cause for concern. Shadow prices of these funds are notoriously resistant to reflecting trends in markets. In September of 2008, 90 percent of prime money market funds had shadow prices within 5 basis points of $1, as reported by the ICI. Nevertheless, when floating NAVs become part of the investor’s framework, it is likely that they will not be as volatile as feared if current trends in the weighted average maturity are any indicator. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. Scalper1 News
Scalper1 News