After years of heated discussions between asset managers and regulators over money market reform, new rules took effect October 14 that, among other things, will allow the net asset value (NAV) of one share of an institutional prime money market fund to float, meaning it will move in line with the value of underlying holdings so investors buy and sell shares based on accurate prices. Asset managers argued that this did not mean that money market funds would break the buck that a share would drop below $1.00. That had historically been considered to be a nearly inconceivable occurrence at least, before it happened to one large fund in 2008.
But after the new rules had been in effect for one day, one fund did just that. The value of the administrative share class of the Morgan Stanley Prime Portfolio, an institutional prime money market fund, dropped from $1.00 to $.9999 just 24 hours after new rules governing the money fund industry were implemented by asset managers on October 17. On October 18, 19, and 20, the administrative share class of the Prime Portfolio was $.9999 per share, according to the Morgan Stanley website. (Prime funds hold corporate commercial paper and other short-term debt.) A Morgan Stanley spokeswoman says the share class has very little in assets, adding, It is not unusual for NAVs to differ slightly in multishare class funds, especially in share classes that have nonmaterial AUM, like the administrative share class.
Two other share classes of the Morgan Stanley Prime Portfolio are trading slightly above $1.00. One is at $1.0002 and the other at $1.0005. And Morgan Stanley has plenty of company. The NAV of the institutional share class of the Fidelity Prime Money Market Portfolio has moved to $1.0004, according to Fidelity Investments website. The NAV of Western Asset Management Co.s Liquid Reserves fund was $1.0003, according to the companys website. The fluctuations show that a variable NAV is, indeed, variable.
Under the Securities and Exchange Commissions new money market reform rules, in addition to allowing the NAVs of prime money market funds to float, fund boards have the power to prevent withdrawals and charge redemption fees on prime funds under certain scenarios. At the same time, the SEC has allowed asset managers to operate more-conservative government money market funds, which hold Treasuries, repurchase agreements, and other securities, with a stable $1.00 NAV.
Although the changes in NAV are small, the evidence flies in the face of fund companies insistence that it would be highly unlikely that a money market fund would again drop below $1.00 after 2008 or that values would change at all. The Reserve Fund, a large money market fund, broke the buck when its Lehman Brothers Holdings investments lost value after the now-notorious investment bank filed for bankruptcy in September 2008. Sophisticated institutional investors like pension funds quickly redeemed their shares at $1.00, forcing Reserve to sell assets and leaving smaller savers with losses once the Reserve Fund adjusted the NAV down to $0.97. The floating NAV and other new rules for prime funds are designed to protect smaller investors from the actions of large institutions in times of market stress.
Investors have used money market funds to park cash since the 1980s, assuming the funds were as safe as bank accounts and certificates of deposit insured by the Federal Deposit Insurance Corp. Fund companies set the net asset value of money market funds at $1.00, meaning investors bought shares for $1.00 and got $1.00 back at any time. But the $1.00 NAV wasnt a statutory requirement, even though fund companies generally assumed any small losses or gains because of price movements in the value of the underlying short-term investments.
The new rules are already reordering the industry, with the prospect of a floating NAV for prime funds scaring off some investors. Investors have pulled $170 billion from mostly prime institutional funds since September 28, according to the Investment Company Institute. That was on top of investors withdrawing $547 billion from prime funds between January 2015 and September 2016. Government funds gained an almost equivalent amount during the time period.
Eric Lansky, president of StoneCastle Cash Management, an institutional cash manager and investor in community banks who wasnt familiar with the Morgan Stanley funds NAV drop when interviewed says most corporate treasurers and other money fund users are unprepared for a money fund with an NAV above or below $1.00. Treasurers may not be sure of the tax treatment of gains and losses or how to account for price changes. Lansky adds that treasurers are also considering alternative cash accounts that have higher yields than the money funds and maintain a $1.00 NAV. StoneCastle has seen, for example, a significant increase in demand for its federally insured cash account (FICA), a proprietary cash management account that offers full federal deposit insurance and next-day liquidity.
Lansky adds that treasurers are also considering whether to switch back to higher-yielding prime funds, even if they have a variable NAV, and whether to invest in separately managed accounts for longer-term cash, which are not subject to the same rules.