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?
What role do money market funds play in the economy?
How are money market funds regulated, and how do money market funds seek to maintain a stable $1.00 net asset value?
What is shadow pricing, and how does it relate to a fund’s NAV?
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?
What is the board’s responsibility with respect to shadow pricing?
What does it mean when I hear that a money market fund “broke the dollar” (or “broke the buck”)?
What happens to investors when a money market fund closes and liquidates?
What is ICI’s Money Market Working Group?
What actions has the SEC taken regarding money market funds?
Where can I find more information on money market funds?
Additional Information about Money Market Funds
A money market fund is a type of mutual fund that seeks to offer investors a variety of features, including return of principal, liquidity, and a market-based rate of return, all at a reasonable cost. 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. In addition, money market funds 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. For institutions of all kinds—businesses, nonprofit organizations, government agencies, and financial institutions—money market funds are a preferred vehicle for cash management.
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” generally means that the money market fund can receive its full principal and interest within 397 days.
Money market funds are generally classified as tax-exempt or taxable, depending on the securities in which they invest. Tax-exempt mutual funds invest in securities issued by state and local governments, agencies, and authorities. The interest paid on these instruments is exempt from federal income tax, and is often exempt from state income taxes when paid to residents of the state in which the securities are issued. Taxable money market funds invest in such instruments as U.S. Treasury securities, federal agency notes, certificates of deposit, Eurodollar deposits, and commercial paper. Money market funds also may invest in repurchase agreements that are collateralized 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 up to 270 days. Money market funds provide an important source of funding in the commercial paper market, holding 37 percent of outstanding commercial paper as of October 2010.
- Jobs: Money market funds hold more than one-third of the commercial paper that businesses issue to finance payrolls and inventories.
- Communities: State and local governments 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 May 2012, tax-exempt money market funds held an estimated 74 percent of outstanding short-term state and local government debt. Tax-exempt money market fund assets totaled $271.6 billion in November 2010.
- Ordinary Americans: Money market funds hold significant amounts of the asset-backed commercial paper that finances credit card, home equity, and auto loans.
- Financing the U.S. government: Money market funds hold one dollar out of every eight in short-term paper issued by the Treasury.
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 SEC, 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, liquidity, 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 are securities of comparable quality. At least 97 percent of a money market fund’s assets must be invested in securities that receive the highest short-term rating or securities of comparable quality (known as “first tier securities”).
- Liquidity: Money market funds must maintain sufficient portfolio liquidity to meet reasonably foreseeable redemption requests. The rule also includes a requirement that all taxable funds maintain 10 percent of assets in “daily liquid assets,” which means cash, U.S. Treasuries, or securities that mature or are subject to a demand feature within one business day. All funds also must have 30 percent of assets in “weekly liquid assets,” which means cash, U.S. Treasuries, other government securities with remaining maturities of 60 days or less, or securities that mature or are subject to a demand feature within five business days.
- 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. Rule 2a-7 makes exceptions to the 5 percent limit for certain securities, including those issued by the federal government or its agencies. The limit is set at 0.5 percent if the issuer has received ratings in the second highest short-term rating category (known as “second tier securities”).
- Maturity: Money market funds must invest in securities that are considered “short-term.” Money market funds cannot acquire a portfolio security with a remaining maturity of greater than 397 days (though exceptions are made for certain types of securities—including variable and floating rate securities—that have a demand feature or an interest rate reset of no more 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 60 days and 120 days, determined without reference to exceptions for interest rate readjustments.
Funds that meet Rule 2a-7’s risk-limiting provisions are allowed to value their securities at amortized cost, rather than at market value. This allows the fund to value its shares at a fixed price (usually $1.00) under a wide range of market conditions.
Money market funds are required to regularly calculate their portfolios’ per-share value at market prices, also known as their “shadow price.” While money market funds have routinely calculated shadow prices for decades, and disclosed them semiannually, the SEC’s 2010 amendments to Rule 2a-7 now require funds to disclose these shadow prices on a monthly basis (with a 60-day lag) to four decimal places (e.g., $1.0005 or $0.9995). For more information, please see ICI’s Frequently Asked Questions About Pricing of U.S. 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. The Treasury operated a temporary, voluntary guarantee program from September 19, 2008, to September 18, 2009. Since the expiration of the Treasury Guarantee Program for Money Market Funds, money market funds carry no federal insurance or guarantees.
An investment in a money market fund is not insured or guaranteed by either the fund’s investment adviser or sponsor. In many cases, however, investment advisers and their affiliates have provided financial support to their money market funds.
Money market funds accounted for 608 of the 7,687 mutual funds available as of May 2012, according to ICI’s monthly survey of the U.S. fund industry.
Money market fund assets account for 22 percent of all mutual fund assets. As of May 2012, approximately $2.6 trillion was invested in money market funds. By comparison, stock funds account for 45 percent ($5.4 trillion) of overall assets. (A weekly report on money market fund assets can be found online.)
Money market funds continued to experience outflows in 2011, but at a much reduced pace from the outflows seen in 2009 and 2010. Outflows in 2009 and 2010 were driven in part by an unwinding of the flight to safety in response to the financial crisis of 2007 and 2008. This effect likely waned in 2011, but other factors continued to limit inflows to money market funds: the low short-term interest rate environment, the European debt crisis, the potential for a default by the U.S. federal government, and the U.S. federal government’s extension of unlimited deposit insurance on non-interest-bearing checking accounts.
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 May 2012, institutional funds held 64 percent of all money market fund assets.
Retail funds are offered primarily to individuals with moderate-sized accounts. As of May 2012, retail money market funds held around 36 percent of all money market fund assets.
No. An enhanced cash fund generally refers to a fund that typically is not registered with the Securities and Exchange Commission (SEC) and that seeks yields slightly higher than those of money market funds by investing in a wider array of securities that tend to have longer maturities and lower credit quality. In seeking those yields, however, enhanced cash funds are not subject to and therefore need not abide by the SEC rule restrictions imposed on money market funds governing the credit quality, liquidity, diversification, and maturity of investments. Enhanced cash funds target a $1.00 NAV, but have much greater potential exposure to fluctuations in their portfolio valuations. Enhanced cash funds are privately offered to institutions, wealthy clients, and certain types of trusts. They may also be referred to as “money market plus funds,” “money market–like funds,” “enhanced yield funds,” or “3(c)(7) funds” (after the legal exception from regulation under the Investment Company Act of 1940, upon which they rely).
“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. Investment guidelines and oversight for GIPs and LGIPs may vary from state to state.
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 if 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.
One of the most important requirements overseen by a fund’s board of directors is the requirement that the fund periodically “shadow price” the amortized cost NAV of the fund’s portfolio against the marked-to-market NAV of the portfolio. When a downgrade, default, or other development causes a difference of more than one-half of 1 percent (or $0.005 per share), the fund’s board of directors must consider promptly what action, if any, should be taken. These actions include whether it should suspend redemptions and liquidate the portfolio or discontinue the use of the amortized cost method of valuation and reprice the securities of the fund below (or above) $1.00 per share, an event known as “breaking the dollar” (or “breaking the buck”).
Alternatively, an affiliate of the fund may take actions to prevent these occurrences. In some cases, the fund’s adviser or affiliate will purchase the troubled security. Regardless of the extent of the deviation, the board of a money market fund also has a duty to take appropriate action whenever the board believes the extent of any deviation may result in material dilution or other unfair results to investors or current shareholders.
If an adverse event—such as the downgrade or default of a portfolio security or a sudden sharp increase in short-term interest rates—pushes the market value of a fund’s portfolio below $0.9950 per share and the fund’s board decides to discontinue the use of the amortized cost method of valuation, the fund is said to “break the dollar,” or “break the buck.” When a fund breaks the dollar, shares are redeemed and investors are repaid at the fund’s NAV, calculated on the day investors 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 SEC and the fund’s independent trustees estimated that investors would recover approximately 99 percent of their principal, or 99 cents per share.
If a fund has broken the dollar, or is at imminent risk of breaking the dollar, it may close to new investors, suspend redemptions, and distribute its assets to investors, in accordance with a plan of liquidation. 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.
The Money Market Working Group is a panel of industry leaders, established by the Executive Committee of ICI’s Board of Governors, which was tasked in November 2008 with finding ways to strengthen the money market and money market funds. The Money Market Working Group submitted its report to ICI’s Board on March 17, 2009.
On March 17, ICI’s Board 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 could be done without regulatory action as soon as possible. Learn more about the Money Market Working Group here.
In June 2009, the SEC proposed reforms for money market fund regulation that in many ways tracked ICI's recommendations (see ICI’s September 2009 comment letter on the proposal). In January 2010, the SEC approved amendments to Rule 2a-7 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 to be prepared for redemption pressure in a market crisis.
The new rules also permit a money market fund that has broken the dollar, or that is at imminent risk of breaking the dollar, to suspend redemptions and liquidate to ensure that all investors—regardless of who is first through the door—are treated fairly.