It’s the most sweeping change for U.S. money market funds in over three decades and the biggest operators say it’ll have a permanent effect on the way investors allocate their capital.
After years of wrangling with regulators, the $2.7 trillion industry will give up its rock-solid, dollar-for-dollar guarantee for institutional funds that invest mainly in riskier, non-government debt.
The impending change has been a boon for the U.S. government and comes at the expense of banks and other corporate borrowers. Already, investors have shifted more than $1 trillion away from so-called prime funds that buy certificates of deposit and company IOUs and flooded into government-only funds, which invest in T-bills and other short-term U.S. debt and are exempt from the change. Assets in those funds, which never exceeded 40 percent before December, now account for 77 percent of all money-market assets, according to Investment Company Institute data going back to 2007.
The $1-per-share fixed price, which gave investors the perception these higher-yielding money-market funds were as safe as bank accounts, will give way to floating values on Oct. 14. The intent has been to make the money-market industry safer and more transparent in the wake of the financial crisis, when the collapse of the $62.5 billion Reserve Primary Fund -- which invested in debt issued by Lehman Brothers Holdings Inc. -- sparked a run on other prime funds and led to hundreds of millions in investor losses.
Yet to BlackRock Inc., Fidelity Investments and Vanguard Group Inc., the influx also represents a long-term shift that may help contain America’s funding costs just as bigger deficits loom and the Federal Reserve considers raising interest rates again. The ramifications are significant as well for banks and other corporate borrowers, which have seen financing costs jump as demand for the prime money-market funds that buy their debt has dried up.
“These are permanent changes,” said Nancy Prior, the president of fixed income at Fidelity, the largest U.S. provider of money-market funds with $470 billion of such assets. “As the features of money funds changed, investors’ preferences led to these shifts in billions of dollars across the market. Assets in government funds will continue to surpass those in prime funds.”
The fixed net asset value has historically meant that money-market investors were always able to get every dollar of their principal back, regardless of the market’s fluctuations. And prime funds, which buy CDs and commercial paper, were an attractive alternative to bank accounts because they delivered slightly higher returns and were perceived to be just as safe.
But this week, the U.S. Securities and Exchange Commission will start requiring institutional prime and tax-exempt money-market funds to float their NAVs. That means that unlike government-only funds, investors can lose money if the market value of such funds fall below $1 per share. In addition, both institutional and retail classes of those funds will be allowed to impose liquidity fees and limit investor withdrawals in times of crisis.
The changes were designed to prevent a repeat of 2008, when the Reserve Primary Fund fell below its $1-a-share mandated value and subsequently collapsed under the weight of its Lehman-related write-offs. It spurred a panic among money-market investors and deepened the financial crisis.