Money Market Funds
Operations and Technology
Mutual Fund Investments in Private Placements: an Overview
By Gregory M. Smith
November 23, 2015
Given recent media interest in mutual fund investments in private placements, it might be helpful to review mutual fund disclosure and valuation obligations. How do funds handle securities that are not publicly traded?
Disclosure and Redemption
Mutual funds must publicly disclose their portfolio holdings on a quarterly basis, not more than 60 days after the period ends. In these disclosures, funds must identify by name each security owned at period end; the number of shares owned (for stocks) or the principal amount (for bonds); and the value of each security. Funds must flag each security that is restricted (i.e., not registered with the SEC under the Securities Act of 1933) and disclose the dollar amount and percentage of the portfolio that is invested in restricted securities. Certain funds may voluntarily disclose their portfolio holdings more frequently (e.g., monthly).
By law, mutual funds must pay redemption proceeds to redeeming shareholders within seven days. For this reason, they typically invest little, if any, of their assets in illiquid securities. In fact, long-standing SEC guidelines generally limit mutual funds from investing no more than 15 percent of their assets in securities that cannot be sold or disposed of within the ordinary course of business within seven days at approximately the value at which the mutual fund has valued the investment.
Mutual funds value their portfolio holdings daily, for purposes of calculating net asset value per share—the price at which investors buy into or sell out of the fund. For securities with readily available market prices (e.g., New York Stock Exchange–listed securities), funds use those prices. For other securities, funds make a good faith determination of the amount for which the security could be sold in a current transaction. Such a determination is called a fair value.
Funds may use a number of different methods to determine the fair value of a security with no readily available market price:
- Market-based methods include applying market-based multiples to historical or projected earnings or cash flows.
- Income-based methods include the discounted present value of future cash flows or capitalized free cash flows.
- Asset-based methods include the replacement cost of the company’s assets or the value of its tangible net assets in liquidation.
The fund’s board of directors must approve the methods used to determine fair values. Because different funds can use different methods and inputs to value a private placement, it should not be surprising that different funds can derive different fair values for the same private placement.
A fund that has a material amount of its portfolio in private placements (a level that it determines, based on the facts and circumstances) must disclose in its financial statement the valuation method used. Generally accepted accounting principles require funds to categorize their portfolios into a three-level hierarchy and disclose the amount invested in each level:
- Level 1 represents securities with quoted prices in active markets.
- Level 2 represents securities valued through reference to other significant observable inputs, including such inputs as quoted prices for similar securities, interest rates, credit spreads, and prepayment speeds.
- Level 3 represents securities without observable inputs that are valued through reference to the fund’s own assumptions.
Funds with a material amount of their portfolios in Level 3 investments must disclose in the notes to their financial statements the valuation methods used to value those investments, as well as the related inputs used and how changes in those inputs would affect the fair value.
Finally, it’s important to keep in mind that a mutual fund’s annual financial statements, including the value of its portfolio holdings, must be audited by an independent public accountant.
Gregory M. Smith is senior director, fund accounting and compliance, in ICI’s Operations department.
Opinion: The Tax Threat to Your Mutual Fund
By Mike McNamee
May 7, 2015
Vanguard Chairman and CEO Bill McNabb sent “an open letter to all mutual fund investors” in the opinion pages of Thursday’s Wall Street Journal. His message: fund investors face a clear threat of higher costs, weaker returns, and a bailout tax to salvage other failing financial institutions—all if regulators get their way in imposing new rules on funds or their managers.
2015 Investment Company Fact Book: Letter from the Chief Economist
By Brian Reid
May 4, 2015
A version of this letter by ICI Chief Economist Brian Reid was released today in our 55th edition of the Investment Company Fact Book.
This year marks the 75th anniversary of the Investment Company Act and the Investment Advisers Act—the key statutes under which mutual funds, exchange-traded funds (ETFs), closed-end funds, and unit investment trusts are regulated and governed. In 1940—the same year that Congress enacted these laws—the fund industry formed the National Committee of Investment Companies, the trade group that became the Investment Company Institute (ICI).
ICI Global Welcomes the Announcement of More Stock Connects in Asia Pacific
By Qiumei Yang
April 22, 2015
In response to the announcement about a launch date for the Taiwan Stock Exchange and Singapore Exchange trading link, and recent reports of a possible Shenzhen–Hong Kong Stock Connect, ICI Global’s Qiumei Yang offers the following comment:
More Unfounded Speculation on Bond ETFs and Financial Stability
By Shelly Antoniewicz and Mike McNamee
April 13, 2015
A recent column in the Financial Times warns of “another accident in waiting” in the growth of fixed-income exchange-traded funds (ETFs)—described as “financial alchemy” that converts illiquid bonds into “baskets” that “trade moment to moment on the stock exchanges.” This “illusory” ETF liquidity will disappear, the author warns, when investors “want to move en masse, and quickly, when the going gets less good.”
Once Again, Information Moves Markets
By Sean Collins
March 18, 2015
Treasury yields fell sharply today and the stock market jumped. Wouldn’t it be nice if mutual funds could take credit? Unfortunately, they can’t. Any orders that mutual fund investors place to buy or sell shares anytime today before 4:00 p.m. won’t hit the market until 4:00 p.m., just like any other day. And, if you are reading this blog post at the time of its posting, 4:00 p.m. is still 10 minutes away.
Does Liquidity in ETFs Depend Solely on Authorized Participants?
By Shelly Antoniewicz and Jane Heinrichs
March 16, 2015
ICI recently conducted a survey of its members that sponsor exchange-traded funds (ETFs) to collect information on authorized participants (APs)—typically market makers or large institutional investors with an ETF trading desk that have entered into a legal contract with an ETF to create and redeem shares of the fund.
Plenty of Players Provide Liquidity for ETFs
By Shelly Antoniewicz
December 2, 2014
A recent article in the Financial Times’ FT Alphaville blog (“Lies, Damned Lies, and Liquidity Expectations”) focused on a paper published by the Committee on the Global Financial System, an organization that monitors developments in global financial markets for central bank governors.
Bloomberg Ignores the Evidence on Bond ETFs
By Mike McNamee
September 26, 2014
In response to “Pimco ETF Probe Spotlighting $270 Billion Market Vexing FSB,” we posted the following comment on Bloomberg News’ website:
A Look Inside ETFs and ETF Trading
By Rochelle Antoniewicz and Jane Heinrichs
September 23, 2014
Investors in exchange-traded funds (ETFs) are trading shares with each other far more than they are turning to authorized participants to create or redeem shares.
The Real Lessons to Be Learned from 1994’s Bond Market
By Brian Reid
July 29, 2014
A recent “Heard on the Street” column in the Wall Street Journal (“Heeding 1994's Bond-Market Lesson,” July 27, 2014) is correct in saying that there’s a lesson to be learned from the 1994 bond market—but it draws the wrong lesson.
SEC Chair White Stresses Need for FSOC to Consult Sources for Necessary Expertise
By Rachel McTague
May 22, 2014
Securities and Exchange Commission (SEC) Chair Mary Jo White today called for the U.S. Financial Stability Oversight Council (FSOC) to use outside expertise to the degree necessary in its process of designating systemically important financial institutions (SIFIs). She asserted that it is “enormously important for FSOC, before it makes any decision of any kind, to make sure it has the necessary expertise on any of those issues.”
“Market Tantrums” and Mutual Funds: A Second Look
By Sean Collins and Chris Plantier
May 19, 2014
Over the past year, policymakers who are focused on financial stability have pursued a theory that mutual fund investors can destabilize financial markets by redeeming from funds when markets decline. According to this theory, redemptions by fund investors lead fund managers to sell securities; those sales drive asset prices down further and, in turn, spur more investor flight, redemptions, and price declines.
ETFs Don’t Move the Market—Information Does
By Shelly Antoniewicz
March 11, 2014
There they go again.