This is the evolution of money market mutual funds, part two.

A little over two years ago, the US Securities and Exchange Commission adopted significant amendments to the rules that govern money market mutual funds under the US Investment Company Act of 1940. According to the SEC’s Money Market Reform, those amendments are designed to address money market funds’ susceptibility to:

• heavy redemptions in times of stress,

• improve their ability to manage and mitigate potential contagion from such redemptions, and

• increase the transparency of their risks, while preserving, as much as possible their benefits.

The deadline to implement these changes by all financial institutions is October 2016, when billions of dollars in money funds will be liquidated and reallocated to transferring these securities into the new required formats.

As the SEC stated: “The SEC is removing the valuation exemption that permitted institutional non-government money market funds (whose investors historically have made the heaviest redemptions in times of stress) to maintain a stable net asset value per share (“NAV”), and is requiring those funds to sell and redeem shares based on the current market-based value of the securities in their underlying portfolios rounded to the fourth decimal place (e.g., $1.0000), i.e., transact at a “floating” NAV.

Further, the SEC also is adopting amendments that will give the boards of directors of money market funds new tools to stem heavy redemptions by giving them discretion

— to impose a liquidity fee if a fund’s weekly liquidity level falls below the required regulatory threshold, and

— giving them discretion to suspend redemptions temporarily, i.e., to “gate” funds, under the same circumstances.

These amendments will require all non-government money market funds to impose a liquidity fee if the fund’s weekly liquidity level falls below a designated threshold, unless the fund’s board determines that imposing such a fee is not in the best interests of the fund. In addition, the SEC is adopting amendments designed

— to make money market funds more resilient by increasing the diversification of their portfolios,

— enhancing their stress testing, and

— improving transparency by requiring money market funds to report additional information to the SEC and to investors.

Finally, the amendments require investment advisers to certain large unregistered liquidity funds, which can have many of the same economic features as money market funds, to provide additional information about those funds to the SEC.”

This is a tremendous amount of investment verbiage — and still only a small fraction completely contained in the 802 page volume. See the SEC link at the end of this article.

Until October technically, institutional (very large) investors and the small person-on-the-street investor are still in the same boat.

Originally, I felt that it was inherently assumed that each and every investor understood that money funds had risks, and might have liquidity problems if many decided to cash out at once.

In actuality, this was not the case. In fact, over the years, individual investors often told me that money funds were guaranteed just like term deposits — simply because the value of each share always stood at $1.00. Of course, I was just appalled at these statements, but it was often quite difficult to convince the individual that money funds are securities, not bank deposits.

Readers, see what I mean — make financial literacy a must goal for yourself this year. We need to understand, at least, the basics of how all of our money is invested.

What are these new categories, will they benefit the small investor, or will the benefit be negated by liquidity fees and gates?

The three categories are:

• Retail money market funds, which may maintain a stable net asset value (NAV) but are subject to liquidity fees and redemption gates.

• Government money market funds, which may maintain a stable NAV but are not required to implement liquidity fees and redemption gates.

• Institutional money market funds, which are required to have a floating NAV and are subject to liquidity fees and redemption gates.

A stable NAV (net asset value, generally, means $1.00 per share). A floating NAV means that the value of the institutional money market mutual funds will float — appreciate up or down with capital market conditions.

Liquidity fees are designed to put a real monetary damper on redeeming shares; some investors will cash out regardless of the penalty.

Redemption gates literally stop any redemption for a certain time frame, in order to allow stabilisation of capital markets and security valuations to occur.

So, reviewing the three categories:

• the government fund has a stable NAV but no fees or redemption gates.

• the retail fund has the same stability, but with liquidity fees and redemption gates.

• the institutional fund is, well, for institutional investors having both floating NAV with capital market valuations, plus liquidity fees and gates.

Is this a good thing for the small investor? Yes, it is. Now, the investor has a choice, low risk and more certainty, or keeping in mind the old mantra: higher returns, higher risk.

Have other global markets made similar changes to their money market mutual fund structures?

We’ll explore that at another time — now that you have reached the saturation point (or boredom) on learning more about money market mutual funds, I’ll leave it here. You do realise, of course, that I could go on and on — not 820 pages long, but pretty long with many other items you really should know about funds, stocks, bonds, Libor manipulation, currency fixing, interest rates, and so on.

Please keep reading and let me know if you are not getting anything out of these articles. I welcome all criticism — how else can I stay on top of the game?

Next week we return to the New Bermuda Retirement Series. Stay tuned.

Sources:

US Securities & Exchange Commission: https://www.sec.gov/rules/final/2014/33-9616.pdf

This is a fascinating document on the entire money market fund investment vehicle structure. But be warned, it is more than 800 pages long. You can have a laugh when at page 720, the Paperwork Reduction Act is cited, before running on another 80 pages. If you do nothing else, read the following sections:

Section 1: Money Market Fund Investors’ Desire to Avoid Loss — page 17

Section 2: Liquidity Risks. When investors begin to redeem a substantial amount of shares, a fund can experience a loss of liquidity — page 18

Section 4: Investors’ Misunderstanding about the Actual Risk of Investing in Money Market Funds — page 22

NAV description: https://en.wikipedia.org/wiki/Net_asset_value

Martha Harris Myron CPA CFP JSM: Masters of Law — International Tax and Financial Services. Pondstraddler Life™ Financial planning perspectives for Bermuda islanders with multinational families and international connections on the Great Atlantic Pond. Contact: martha@pondstraddler.com