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Frequently Asked Questions About Money Market Funds

What are money market funds, and how do investors use them?
What types of investments do money market funds hold?
How are money market funds regulated, and how do money market funds seek to maintain a stable $1.00 net asset value?
Does the federal government insure money market funds?
Does the money market fund’s investment adviser or sponsor insure the fund?
How many money market funds are there?
What is the percentage of total mutual fund assets held in money market funds?
What are the recent trends in money market fund assets?
What are institutional money market funds?
What are retail money market funds?
Are “enhanced cash management” products the same as money market funds?
What are “government investment pools” or “local government investment pools”?
What role do boards play in overseeing money market funds?
What is the board’s responsibility in the event that a security in a money market fund’s portfolio is downgraded or defaults?
I’ve heard that a money market fund “broke the dollar” (or “broke the buck”). What does that mean?
What happens to investors when a money market fund closes and liquidates?
What is ICI’s Money Market Working Group?
Where can I find more information on money market funds?

 What are money market funds, and how do investors use them?

A money market fund is a type of mutual fund that invests in high-quality, short-term securities that present minimal credit risk. These funds also pay dividends that generally reflect short-term interest rates. Although the net asset value (“NAV”) per share of a traditional mutual fund changes daily in response to market factors, money market funds are structured to avoid these changes by seeking to maintain a stable share price, typically $1.00 per share.

Investors use money market funds for a variety of reasons. Like other mutual funds, money market fund shares can be bought or sold at any time. Money market funds also often provide check-writing privileges for shareholders. Some investors use money market funds as a “parking place” for cash between investments because money market fund yields are typically competitive with those of most savings accounts.

 What types of investments do money market funds hold?

Federal regulations prohibit a money market fund from acquiring any investment that is not (1) short-term, (2) determined to present minimal credit risks, and (3) either highly rated or determined to be comparable in quality to highly rated securities. “Short-term” means that the money market fund can receive its full principal and interest within 397 days. Moreover, regulations prohibit the average maturity of the fund’s investments from exceeding 90 days, and almost all funds maintain a much shorter average maturity.

Taxable money market fund investments include U.S. Treasury securities, federal agency notes, commercial paper, certificates of deposit, and Eurodollar deposits. Money market funds also may invest in repurchase agreements that are collateralized fully by U.S. Treasury and agency securities or other high-quality securities.

Commercial paper is issued by a wide variety of corporations—such as domestic and foreign firms, banks, finance companies, and broker-dealers—and carries repayment dates that typically range from overnight to up to 270 days. Commercial paper can be unsecured or asset-backed. Unsecured commercial paper is a promissory note backed only by a borrower’s promise to pay the face amount on the maturity date specified on the note. Firms with high-quality credit ratings are often able to issue unsecured commercial paper at interest rates that are typically less than bank loans. Asset-backed commercial paper is backed by a pool of underlying assets (e.g., mortgage-backed securities, auto loans, credit card receivables). Money market funds provide an important source of funding in the commercial paper market, holding about 40 percent of outstanding commercial paper as of October 2009.

State and local governments also rely on tax-exempt money market funds as a significant source of funding for public projects such as roads, bridges, airports, water and sewage treatment facilities, hospitals, and low-income housing. As of December 2008, tax-exempt money market funds had $491 billion under management and held an estimated 65 percent of outstanding short-term state and local government debt.

 How are money market funds regulated, and how do money market funds seek to maintain a stable $1.00 net asset value?

 Money market funds are strictly regulated by the Securities and Exchange Commission, both as mutual funds generally and pursuant to Rule 2a-7 under the Investment Company Act of 1940. Rule 2a-7 includes several conditions intended to help a fund stabilize its share price at $1.00. These conditions limit risk in a money market fund’s portfolio by governing the credit quality, diversification, and maturity of money market fund investments. 

• Credit Quality: Money market funds are required to hold high-quality securities that pose minimal credit risks and have received ratings in the top two categories from two nationally recognized statistical rating organizations (NRSROs) (unless only one NRSRO rates the security or issuer of debt), or securities of comparable quality. For taxable money market funds, at least 95 percent of a money market fund’s assets must be invested in securities that received the highest short-term rating or securities of comparable quality (known as “First Tier Securities”). 
• Diversification: Money market funds must maintain a diversified portfolio. This requirement limits a fund’s economic exposure to any single issuer. In general, money market funds may not invest more than 5 percent of assets in the securities of any single issuer. The limit is set at 1 percent if the issuer has received ratings in only the second highest short-term rating category (known as “Tier 2 securities”). The rule makes exceptions to the 5 percent limit for certain securities, including those issued by the federal government or its agencies. 
• Maturity: Money market funds must invest in securities that are considered “short-term.” In general, money market funds cannot acquire a portfolio security with a remaining maturity of greater than 397 days. In addition, a money market fund’s weighted average maturity (WAM)—an average of the maturities of all securities held in the portfolio, weighted by each security’s percentage of net assets—must not exceed 90 days. Almost all money market funds maintain a much shorter WAM.

 Does the federal government insure money market funds?

An investment in a money market fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other federal agency. On September 29, 2008, the U.S. Department of Treasury opened a program to guarantee the holdings of any publicly offered eligible money market fund—both retail and institutional—that paid a fee to participate in this program. The Treasury Guarantee Program for Money Market Funds was voluntary, and each fund determined whether to participate. The Guarantee Program expired on September 18, 2009. 

 Does the money market fund’s investment adviser or sponsor insure the fund?

An investment in a money market fund is not insured or guaranteed by either the fund’s investment adviser or sponsor. However, in many cases, investment advisers and their affiliates have provided financial support to their money market funds.  

 How many money market funds are there?

Money market funds accounted for 719 of the 7,762 mutual funds available as of October 2009, according to ICI’s monthly survey of the U.S. fund industry. 

 What is the percentage of total mutual fund assets held in money market funds?

Money market fund assets account for 31 percent of all mutual fund assets. As of October 2009, approximately $3.4 trillion was invested in money market funds. By comparison, stock funds account for 43 percent ($4.6 trillion) of overall assets. (A weekly report on money market fund assets can be found online.)  

 What are the recent trends in money market fund assets?

In 2009, through October, money market funds experienced net outflows of $490 billion after two years of substantial inflows ($654 billion in 2007 and $637 billion in 2008). In 2007 and 2008, much of the surge in inflows was directed to taxable government money market funds and likely reflected investors’ flight to safety amid the turmoil of the financial crisis. Taxable government money market funds hold U.S. federal government debt; tax-exempt money market funds hold state and local government debt. 

As financial markets stabilized in 2009, investors appear to have become less risk averse and have been withdrawing money from government money market funds. Institutional and retail investors pulled $310 billion and $89 billion, respectively, from taxable government money market funds in the first 10 months of 2009.

The low interest rate environment has also likely played a role in outflows from retail money market funds. Through October 2009, retail investors withdrew $118 billion from taxable non-government money market funds. Retail investors tend to withdraw cash from money market funds when the interest rate spread between the money market deposit accounts and money market funds narrows to a low level. In contrast, institutional investors put $111 billion in cash into taxable non-government money market funds. For more information on recent trends in money market fund assets, see ICI’s statistics page.  

 What are institutional money market funds?

Institutional funds are held primarily by businesses, governments, institutional investors, and high net worth households. They are also used by individuals that invest through institutional share classes, such as those used by 401(k) plans or broker or bank sweep accounts. As of October 2009, institutional funds held 67 percent of all money market fund assets.  

 What are retail money market funds?

Retail funds are offered primarily to individuals with moderate-sized accounts. As of October 2009, retail money market funds held around 33 percent of all money market fund assets.  

 Are “enhanced cash management” products the same as money market funds?

No. An “enhanced cash management” product generally refers to a fund that is typically not registered with the SEC and that seeks yields slightly higher than those of money market funds. In seeking those yields, however, enhanced cash products can exceed the SEC restrictions imposed on money market funds governing the credit quality, diversification, and maturity of investments. These products are typically offered to institutions as private placements, separate accounts, or certain types of trusts. They also may be referred to as “money market–plus” funds, “money market–like” funds, or “enhanced yield” funds.

 What are “government investment pools” or “local government investment pools”?

“Government investment pools” (GIPs) or “local government investment pools” (LGIPs) typically refer to state- or county-operated funds offered to cities, counties, school districts, and other local and state agencies that enable them to invest money on a short-term basis. The agencies expect this money to be available for withdrawal when they need it to make payrolls or pay other operating costs. Most of these products are not registered with the SEC and therefore are not subject to SEC rules for money market funds, which govern the credit quality, diversification, and maturity of investments. Investment guidelines and oversight for GIPs and LGIPs may vary from state to state.  

 What role do boards play in overseeing money market funds?

A money market fund’s board of directors is primarily responsible for ensuring that the fund complies with the SEC’s conditions to limit risk in the fund’s portfolio. The board establishes written guidelines and procedures reasonably designed to stabilize the fund’s $1.00 NAV. The board also must exercise adequate oversight (e.g., through periodic reviews of fund investments) to ensure that those guidelines and procedures are being followed.

 What is the board’s responsibility in the event that a security in a money market fund’s portfolio is downgraded or defaults?

If a security in the fund’s portfolio is downgraded, the fund’s board (or its delegate, such as the fund’s adviser) must promptly determine whether the security continues to present minimal credit risk. The board or its delegate must cause the fund to take whatever action is determined to be in the fund’s best interests. If a security defaults, the fund must dispose of the security as quickly as possible, unless the fund’s board determines that doing so would not be in the fund’s best interests.

When a downgrade, default, or other development threatens to lower the fund’s NAV below $1.00, an affiliate of the fund may take certain actions to prevent this occurrence. In some cases, the fund’s adviser or affiliate will purchase the troubled security. This type of action should be brought to the board’s attention, and in some instances, may require SEC approval.  

 I’ve heard that a money market fund “broke the dollar” (or “broke the buck”). What does that mean?

A money market fund “breaks the dollar” when it is unable to repay its $1.00 NAV per share.

When a fund breaks the dollar, shares are redeemed and investors are repaid at the fund’s NAV, calculated on the day they place their redemption order.

This has happened twice since the inception of money market funds. In 1994, a small institutional money fund broke the dollar; investors ultimately received 96 percent of their principal. On September 16, 2008, a money market fund announced that its NAV that day was 97 cents, due to a sharp write-down in some securities the fund held. That fund would later be liquidated. In September 2009, the Securities and Exchange Commission and the fund’s independent trustees estimated that investors would recover approximately 99 cents per share. 

 What happens to investors when a money market fund closes and liquidates?

In some cases, a fund will close to new investors and distribute its assets to investors, in accordance with the distribution terms in its prospectus. A fund might do this to provide equitable treatment to all investors in the face of significant redemption pressure that might lead to a forced sale of the fund’s assets.

 What is ICI’s Money Market Working Group?

The Money Market Working Group is a panel of industry leaders that was tasked in November 2008 with finding ways to strengthen the money market and money market funds. Established by the Executive Committee of the Board of Governors of the Investment Company Institute, the Money Market Working Group submitted its report to ICI’s Board on March 17, 2009.

On March 17, the ICI’s Board of Governors passed a resolution strongly endorsing the recommendations of the Working Group and urging all ICI money market fund members to take actions to implement those recommended practices that can be done without regulatory action as soon as possible. Learn more about the Working Group and its recommendations here. 

In June, the SEC proposed reforms for money market fund regulation that in many ways tracked the ICI recommendations (see ICI’s September 2009 comment letter on the proposal). The SEC in January 2010 approved reforms that would strengthen money market funds by:

• Tightening standards for credit quality of fund assets;
• Shortening portfolio maturities;
• Enhancing disclosure;
• Requiring funds to meet explicit standards for holding liquid assets; and
• Requiring stress testing and “know your customer” procedures to help funds be prepared for redemption pressure in a market crisis. 

In addition, if a money market fund can’t maintain a stable net asset value (NAV) per share, the new rules permit the fund’s board of directors to suspend redemptions to ensure that all investors—regardless of who is first to the door—are treated fairly.

 Where can I find more information on money market funds?

• Money Market Fund Resource Center (Investment Company Institute)
• Media Advisory: Reporting on Money Market Mutual Funds (Investment Company Institute)
• Money Market Mutual Fund Assets (Investment Company Institute)
• Frequently Asked Questions About the Treasury’s Temporary Guarantee Plan for Money Market Mutual Funds (Investment Company Institute)
• Frequently Asked Questions About ICI’s Money Market Working Group (Investment Company Institute)
• Money Market Funds (U.S. Securities and Exchange Commission)

February 2010