After money market funds “broke the buck” in the financial crisis of 2008, regulators honed in on money funds, questioning whether or not their $1 target can hold up through various market stresses. Regulators have not moved on from the issue, and any potential changes to the way money market funds operate could make short-duration bond exchange-traded funds an attractive alternative.

Money market funds are yielding next to nothing, but at least investors have the peace of mind that they “can’t lose money.” The assets serve as a safe place to park cash while waiting to take on other areas of the market.

However, money market reform talks have gained momentum in recent years after the largest money fund, the Reserve Primary Fund, “broke the buck,” or dipped below $1 per share, after the collapse of Lehman Brothers, one of the fund’s investments. According to federal guidelines, money funds are not allowed to deviate from $0.9950 and $1.0050 per shares. In the event the fund dips below $0.9950, a money market fund could face liquidation. As previously witnessed, the Lehman collapse fueled wide spread panic, with investors making a run on the money fund. The loss of confidence in these cash safeguard investments put investor confidence in the whole financial markets at risk.

Consequently, the Federal Reserve had to step in and provide a backstop or guarantee to support the money funds.

With $2.7 trillion in assets under management, or twice the size of the exchange-traded fund universe, a good chunk of wealth is in the cross-hairs as regulators consider reforms to prevent another run on money market funds. Regulators want to reform the way money market funds do business, notably by letting the net asset value float or fluctuate beyond $1, but they are up against a strong lobby with deep pockets. The fund industry is against any changes and would rather keep the implied government backstop for money market funds in place.

The government does not want to bail out money market funds again. Consequently, the Financial Stability Oversight Council is considering various options for U.S. money market fund reforms, including a floating net asset value, which would allow money funds to  shift away from $1 parameter; a capital buffer of up to 1% of the fund’s value, along with a delay on redemptions; or a buffer of up to 3%. With a floating NAV, money markets would be impaired in a rising rate environment. Moreover, any added regulations and restrictions would further weigh on their returns.

Reform talks have stalled after the Securities and Exchange Commission failed to achieve a majority vote to proceed with former Chairman Mary Schapiro’s proposals. However, with SEC Commissioner Elisse Walter, a supporter of Schapiro’s changes, to step up as the next SEC chairman, the SEC may not forget about reforms to the money market funds. Recently, Commissioner Daniel Gallagher revealed that the SEC is working on a new money market fund reform plan, and he expects a new proposal to be ready for comment sometime in the first quarter.

As a way to appease regulators, major institutions that offer money market funds have announced that they will post the net asset values of some funds on a daily basis after resisting efforts by regulators. BlackRock, Charles Schwab, Federated Investors, Fidelity, Goldman Sachs Asset Management and JPMorgan Chase have made concessions to provide greater transparency. Some industry observers believe that this will only serve as a band aid and stall more severe regulation. However, the increased transparency could also have the unintended effect of confusing the average investor as the daily NAV would allow investors to see the miniscule changes between the $0.9950 and $1.0050 price range.

Since the money market funds typically trade at a fixed net asset value of $1 and have been investors' safe haven for cash, any changes that put the $1 standard at risk would have far reaching consequences on the $2.7 trillion money fund market.

The Short-Duration Bond ETF Option
Since money market funds are primarily used as a no-frills, safe store for cash, advisors can consider looking into bond ETFs with ultra-short durations as these funds offer investors greater protection against interest rate risk, compared to long-term bonds.

The effective duration is a measure of a fund’s interest-rate sensitivity—the longer the duration, the more sensitive it is to interest rate changes. Typically, the duration is a good indicator of how a fund’s net asset value will act due to interest rate changes. For example, a fund with a five-year duration would likely drop 5% if interest rates rise 1%, or vice versa.

The actively managed PIMCO Enhanced Short Maturity Strategy (MINT) has an effective duration of 0.97 years. MINT tries to generate income and total return greater than money market funds by investing in short-duration investment grade debt (48%), government related debt (5%), mortgage debt (18%), municipals (14%) and emerging markets (2%). The top country allocations include the U.S. (56.9%), U.K. (7.5%), Canada (7.0%), France (4.1%) and Sweden (4.0%). However, advisors should be aware that the fund does not guarantee a fixed price level as it may hold slightly speculative securities nor does it have an implicit government backstop. The ETF has a 0.88%, 30-day SEC yield and a 0.35% expense ratio.

The Guggenheim Enhanced Short Duration Bond (GSY) is another actively managed ETF that tries to outperform the Barclays Capital 1-3 Month U.S. Treasury Bill Index. The ETF holds corporate bonds (21.5%), bank loans (5.8%), and cash equivalents (67.4%). Moreover, the fund can hold up to 10% of its assets in foreign sovereign and corporate debt and up to 10% of its assets in asset-backed securities. GSY has an effective duration of 0.42 years, a 0.27% expense ratio and a 1.14% 30-day SEC yield.

On the other hand, advisors can consider ultra-short-duration Treasury bond ETFs, such as the SPDR Barclays 1-3 Month T-Bill (BIL), which tracks the Barclays Capital 1-3 Month U.S. Treasury Bill Index. The index is comprised of zero-coupon Treasury bills with one- to three month maturities. The ETF will roll over its position as each holding approach one month to maturity as a way to maintain its duration between one and three months. BIL has a 0.1345% expense ratio, 0.12 year averaged duration and a -0.08% 30-day SEC yield.

Similarly, the iShares Short Treasury Bond ETF (SHV) offers exposure to Treasury bonds with maturities up to one year for those comfortable with a slightly longer duration than BIL. Consequently, it has a 0.43 year average duration. SHV also comes with a 0.15% expense ratio and a 0.02% 30-day SEC yield.

With the increased scrutiny on money market fund market, advisors should begin to consider potential alternatives as a backup plan in case regulators do decide to bring down the hammer.