On October 14, 2016, reforms for money market funds go into effect which will change the landscape for short-term cash investing. In the coming weeks, there will likely be news on these changes and their impact. Ahead of that, we would like to take this opportunity to explain the reason behind the reforms and what these reforms mean for you.
Why money market reform?
Unlike stock and bond mutual funds, which have net asset values (NAV) that fluctuate day-to-day as the securities owned by the mutual fund fluctuate, money market mutual funds have historically had a fixed NAV of $1/share. However, at the peak of the 2008 financial crisis, the Reserve Primary Fund, a large New York-based fund manager, was forced to reduce the net asset value (NAV) of its money market fund below $1/share due to massive losses from short-term investments in Lehman Brothers loans. This was the first time a major money market fund “broke the buck.” Investors panicked, mass redemptions followed and ultimately, the Reserve Primary Fund money market was forced to suspend its operations and liquidate.
In the years following the financial crisis, a series of financial reforms were considered and implemented including new rules for money market funds intended to enhance their stability in times of financial stress. These new rules become effective this October.
What will change?
The most fundamental change is the requirement that certain money market funds move from a fixed $1/share NAV to a floating NAV. This means that in times of extreme financial stress, it is possible that the price of affected money markets could fall below $1/share.
The other major change requires money market providers to implement a structure to prevent mass withdrawals (redemptions). A redemption fee of either 1% or 2% could be assessed if liquid assets fall below certain levels. And, money market providers may inhibit your ability to withdraw money (a gate) for up to 10 days in a 90-day period if need be.
Some money markets will be subject to a floating NAV and redemption fees/gates while others will only be subject to the fees/gates. However, money market funds through FDIC-insured banks and those which invest solely in U.S. government securities are exempt from the reforms. We believe these money markets make the most sense for you.