Frequently Asked Questions About 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 NAV of $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 fund yields are typically competitive with those of most savings accounts.

There are a number of cash-management vehicles available that don't meet the strict standards for money market funds and that, typically, are not SEC-regulated products. These are often referred to in the press as "similar to money market funds" or "money market-like funds." However, these vehicles are not subject to the same risk limiting provisions as true money market funds.

Additional Information about Money Market Funds

What types of investments do money market funds hold?
Typically, tax-exempt money market funds, which seek to pay dividends that are exempt from federal income tax and/or state income tax, invest in instruments issued by state and local governments ("municipal securities"). Some of these securities may employ credit enhancements, such as bond insurance.

Taxable money market fund investments include U.S. Treasury securities, federal agency notes, certificates of deposit, and commercial paper.

Commercial paper consists of short-term notes issued by a wide variety of corporations, such as domestic and foreign firms, banks, finance companies, and issuers of commercial paper. About 85 percent of outstanding commercial paper has received the highest short-term rating by at least one credit rating agency (also known as nationally recognized statistical rating organizations (NRSRO)), or if unrated, is of comparable quality. Asset-backed commercial paper, which is a type of commercial paper backed by a pool of assets, accounts for about half of the total commercial paper outstanding. Money market funds hold less than 30 percent of outstanding commercial paper.

How do money market funds seek to maintain a stable $1.00 net asset value?
Money market funds are stringently regulated by the U.S. Securities and Exchange Commission (SEC) pursuant to Rule 2a-7 under the Investment Company Act of 1940. Rule 2a-7 includes several conditions intended to stabilize a fund's $1.00 NAV. 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. In general, money market funds may invest in: securities that have been rated in one of the two highest short-term rating categories by two NRSROs (unless only one NRSRO rates the security or issuer of debt); or securities of comparable quality, as determined by the money market fund's board of directors.
  • Diversification: Money market funds must maintain a diversified portfolio. This requirement limits a fund's economic exposure to any single issuer. For instance, in general, money market funds may not invest more than 5 percent of assets in the securities of any single issuer, with the exception of securities issued by the federal government.
  • 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.

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 and 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 to do 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.

Has a money market fund ever "broken the buck"?
"Breaking the buck" occurs when a money market fund is unable to repay its $1.00 NAV per share. Since Rule 2a-7 was adopted in 1983, only once has a money market fund failed to repay the full principal amount of its shareholders' investments. In that case, a small institutional money market fund in 1994 "broke the buck," paying investors $0.96 per share.

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 government agency.

How many money market funds are there?
Money market mutual funds accounted for 810 of the 8,017 funds available as of December 2007, 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 26 percent of all mutual fund assets. As of December 2007, approximately $3.1 trillion was invested in money market funds. By comparison, stock funds account for 54 percent ($6.5 trillion) of overall assets. (A weekly report on retail and institutional money market fund assets can be found on the Institute's website.)

Share of Total Mutual Fund Assets by Category

Note: Components may not add to 100 percent because of rounding.

What are the recent trends in money market fund assets?
Assets of money market mutual funds have increased significantly since 2004, rising about 60 percent to a level of $3.1 trillion by the end of 2007. This increase primarily reflected very significant inflows to institutional money market funds, and to a lesser extent inflows to retail money market funds in 2007.

Money Market Fund Assets
(billions of dollars)

What are institutional money market funds?
Institutional funds are held primarily by businesses, governments, institutional investors, and high-net worth households. Institutional funds hold 60 percent of all money market fund assets.

What are retail money market funds?
Retail funds are offered primarily to individuals with moderate-sized accounts. Retail money market funds hold around 40 percent of all money market fund assets.

Are "enhanced cash" management products the same as money market funds?
No. "Enhanced cash" products is a general term that refers to funds that are typically not registered with the SEC and that seek yields slightly higher than those of money market funds. In seeking those yields, however, enhanced cash products can exceed the SEC rule 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 so they can 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. The majority of these products currently available 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 also may vary from state to state.

What are credit enhancements?
Issuers of securities use credit enhancements to raise the credit rating of a security by backing it with the credit of a third party. Credit enhancements (for example, bond insurance and bank letters of credit) can help lower the risk of default, improve liquidity, and reduce the interest rate that issuers must pay.

Bond insurance, for example, unconditionally guarantees the payment of principal and interest on the bond if the issuer of the bond defaults. Generally, this guarantee improves the credit rating of the bond, because insured bonds typically are rated based on the credit of the insurer rather than the underlying credit of the issuer.

Tax-exempt money market funds often hold municipal securities insured by a bond insurance company. If a bond insurer is downgraded, it does not necessarily mean that the security is ineligible to be held in the money market fund. However, if the bond insurer is downgraded to the point where neither the insurer's rating nor the bond issuer's rating meets the standards for money market fund holdings, a money market fund must promptly determine whether it may continue to hold these securities.

Where can I find more information on money market funds?
ICI offers a guide to understanding mutual funds as part of its Investor Awareness series, conducts research on U.S. household ownership of money market and other types of mutual funds, and tracks assets and other statistical data on money market and other types of mutual funds.

February 2008

  

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