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ARCHIVE
The Honest Truth About Forcing Money Market Funds to Float
By Brian Reid
February 29, 2012
Advocates for further regulation of money market funds string together a loose chain of arguments to create the impression that money market funds are bank products, rather than investment securities. From this, they conclude that these funds need bank-like regulation. Sallie Krawcheck’s commentary in today’s Wall Street Journal is the latest effort in this campaign.
The reasoning usually goes like this: money market fund investors don’t know what they’re buying. Because the funds are managed to maintain a $1.00 share price, advocates of regulation argue that investors are lulled into believing that money market funds carry implicit guarantees. There’s usually a reference to “honest accounting,” with the implication that fund sponsors are hiding large fluctuations in the shares’ “true prices.” The solution, advocates say, is to “float” the share price, pass all those fluctuations on to investors, and thus demonstrate to investors that what they’re holding is not a static bank account, but a security that carries risks.
There are flaws in every link of this chain—starting with the premise that investors are ignorant. Holders of institutional funds, which account for more than three-fifths of the $2.7 trillion invested in money market funds, certainly know the difference between a fund and a bank account. And retail investors are not ill-informed, either: in recent surveys by Fidelity Investments, 81 percent of retail investors said they understood that the securities held by money market funds had some small daily price fluctuations.
The notion that funds maintain their stable $1.00 price through implicit guarantees is also wrong. In truth, portfolio construction explains most of the stability: money market fund portfolios are designed to minimize risk and price fluctuations.
Money market funds invest in very short-term securities, and many of these securities have interest rates that reset frequently. That makes the value of these securities—and hence the funds’ per-share portfolio value—extremely stable. As my colleagues and I wrote in a paper last year, interest rates would have to rise by 1 percentage point in a single day to reduce the portfolio value of the average $1.00 fund with a 45-day weighted average maturity by $0.0012 (about 0.1 cent). How often do such extreme interest rate changes occur? In the past 30 years, there has only been one day (February 1, 1982, to be specific) when three-month Treasury bill rates changed by more than 1 percentage point.
The stability of money market fund portfolios is demonstrated in historical data. For our paper, we collected mark-to-market prices from a sample of money market funds from 2000 to 2010. For prime funds (those that invest in commercial paper as well as government securities), the average “shadow price” never fell more than 0.1 cent below $1.00 until September 2008, when interest rates rose over several days. And even then—at the worst point in the worst financial crisis in 70 years—the average shadow price was only 0.2 cents below $1.00.
That record of stability was earned before the Securities and Exchange Commission (SEC) adopted amendments to money market fund regulation in 2010 that required funds to shorten the maturities and durations of their portfolios even further and to carry more liquid assets. Those rule amendments have made funds’ mark-to-market share prices even more stable.
We’ve had a case study to prove that point. Last summer, three significant events rattled financial markets. The eurozone struggled to get ahead of the growing possibility of a Greek sovereign debt default. The U.S. Congress waited until the eleventh hour to increase the U.S. debt ceiling. And then, shortly afterward, Standard & Poor’s downgraded the rating of U.S. government long-term debt.
What happened to money market funds’ mark-to-market prices during the period from the end of May to the end of September? Very little. Using data that these funds provide to the SEC for public release, we can track the underlying prices of prime money market funds.
Among those funds that held the greatest share of their portfolios in dollar-denominated debt issued by the European-based financial institutions, the average share price of a fund with a $1.00 net asset value (NAV) fell by 0.9 basis points, or $0.00009. In other words, the price of a $1.00 fund slipped to $0.99991. For funds with the least exposure to European banks, the average mark to market share price rose by 0.3 basis points, or $0.00003, to $1.00003.
When a $1.00 fund moves by 1 cent, it’s said to have “broken the dollar.” In last summer’s scenario, funds would have to have been priced at $100.00 a share for even a few funds to have moved one penny. (Maybe “break the Benjamin” would be the new term of art.) In any case, it’s hard to argue that pricing a $0.99991 share at $1.00 is somehow not “honest accounting.”
Some commentators believe that this type of fluctuation will convince investors that these funds contain assets that can lose value or provide more “honest accounting.” False precision is not honest, and it is hard to imagine that investors would find these fluctuations to be meaningful. Floating the value of money market funds would create distinctions without a difference—an illusory benefit at best.
At the same time, the costs—in accounting, transactional, and tax hurdles for investors forced to track these minute changes in every transaction they make—will be very real, and very expensive. As we have said many times before, floating the price or imposing bank-like regulation will serve primarily to drive investors out of money market funds.
For more information, please visit ICI’s Money Market Funds Resource Center.
Brian Reid is ICI’s Chief Economist.
TOPICS: Fund RegulationMoney Market Funds
The ‘Hue and Cry’ over Money Market Funds Is a Chorus of Many Voices
By Paul Schott Stevens
February 24, 2012
Securities and Exchange Commission Chairman Mary Schapiro took aim at money market funds again today, this time lamenting “the hue and cry being raised by the industry” against the proposals that she champions.
TOPICS: Fund RegulationMoney Market Funds
Regulating Funds’ Use of Derivatives: Striking a Fine Balance
By Robert C. Grohowski and Mara L. Shreck
February 23, 2012
Much has been written about the dangers of derivatives, from Warren Buffett’s quote about “financial weapons of mass destruction” to media coverage of derivatives’ role in various aspects of the financial crisis, such as the downfall of AIG. Far less attention has been paid to the benefits that derivatives can provide for mutual funds and their investors—allowing funds to mitigate risks, manage portfolios more efficiently, and access new strategies.
TOPICS: Financial Markets
The (Dis)Connection Between ETFs and Market Volatility
By Rochelle Antoniewicz
February 23, 2012
In the past year, many commentators have charged that exchange-traded funds (ETFs) are responsible for driving stock market volatility to unprecedented extremes.
TOPICS: Exchange-Traded FundsFinancial Markets
Prime Money Market Funds’ Eurozone Holdings Remain Low
By Emily Gallagher and Chris Plantier
February 23, 2012
Securities of eurozone issuers accounted for 14.0 percent of assets of U.S. prime money market funds in January, up from 11.9 percent in December (chart). This increase was driven by a rise in French assets (up from 3.2 percent to 4.6 percent) and by a rise in asset holdings of other eurozone issuers (up from 8.7 percent to 9.4 percent).
TOPICS: Financial MarketsMoney Market Funds
Proposal to Implement the Volcker Rule Raises Deep Concerns for U.S. Registered Funds
By Paul Schott Stevens
February 14, 2012
Congress enacted the provision of the Dodd-Frank Act known as the Volcker Rule to restrict banks from using their own resources to trade for purposes unrelated to serving clients—something known as “proprietary trading.”
TOPICS: Exchange-Traded FundsFinancial MarketsFund Regulation
Proposal to Implement Volcker Rule Raises Significant Issues for Regulated Funds Globally
By Dan Waters
February 14, 2012
Congress enacted the provision of the Dodd-Frank Reform Act known as the Volcker Rule to restrict banks from sponsoring and investing in hedge funds (so-called covered funds) and using their own resources to trade for purposes unrelated to serving clients—something known as “proprietary trading.”
TOPICS: Fund RegulationICI GlobalInternational
A Bad Diagnosis Could Be Fatal for Money Market Funds
By Paul Schott Stevens
February 13, 2012
Bad diagnosis leads to bad prescriptions—and the errors can be fatal. The Wall Street Journal’s lead editorial today, “Money Fund Make-Over,” falls into that trap.
The Rx of this editorial is premised on the notion that money market fund investors don’t understand that they’re just that—investors. Yet every fund’s prospectus provides a clear description of all risks and rewards associated with the fund. No fund offers any expectation of an explicit or implicit guarantee by the fund sponsor or the U.S. government. That message is repeated in virtually every communication from money market funds to investors.
TOPICS: Fund RegulationMoney Market Funds
Amended CFTC Rule 4.5 Appears to Impose Unnecessary Burdens on Many Mutual Fund Advisers
By: Rachel McTague
February 10, 2012
On February 8, the Commodity Futures Trading Commission (CFTC) issued amended Rule 4.5, a regulation governing commodity pool operators (CPOs), as well as a related rule proposal. Among other changes, the amendments to the rule significantly narrow the ability of registered investment advisers to rely on the rule’s exclusion from regulation as a CPO. As a result, many advisers will be required to register with the CFTC even though they are already regulated by the Securities and Exchange Commission (SEC).
Achieving the Proper Balance on FATCA
By Keith Lawson
February 8, 2012
ICI and ICI Global have engaged actively with Treasury and the Internal Revenue Service (IRS) as they have crafted the proposed Foreign Account Tax Compliance Act (FATCA) regulations, which were issued today. Our message has been simple: ensure that the tax compliance benefits anticipated by FATCA, which we support strongly, justify the costs that will be imposed.
TOPICS: Taxes
The SEC’s Money Market Fund Plans—Scoring a Hat Trick Against Investors and the Economy
By Paul Schott Stevens
February 7, 2012
The Wall Street Journal reports today that the Securities and Exchange Commission (SEC) continues to pursue regulatory changes for money market funds that will harm investors, damage financing for businesses and state and local governments, and jeopardize a still-fragile economic recovery. Quite a regulatory hat trick.
TOPICS: Fund RegulationMoney Market Funds
An Important Step in the Process of Enhancing 401(k) Fee Disclosure
By Ianthé Zabel
February 3, 2012
On February 2, the Department of Labor (DOL) issued final regulations concerning 401(k) disclosures. The rule requires companies that administer defined contribution plans to disclose administrative and investment costs to employers who sponsor the plans.
TOPICS: 401(k)Retirement Policy
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