As a follow up to last year’s discussion on proposed money market reforms, we can now report that the U.S. Securities and Exchange Commission (SEC) has finished its work, and the reforms have been finalized. The new rules, which will go into effect in October of this year, were put in place in order to stem market disruptions similar to those encountered during the financial crisis of 2008. You may recall that during the crisis the markets for short-term commercial paper and other money market instruments were basically frozen. This after the Reserve Fund (one of the largest domestic money funds at the time), saw a large decline in the value of its investments, and was forced to “break the buck”. Investors started a huge “run” on the fund thereafter, and only when the Federal Reserve stepped in with massive cash injections did the bloodletting finally stop. The current reforms are designed to both prevent a recurrence of the 2008 debacle, and promote more stable money markets generally.
The key remedy regulators chose in order to stabilize money markets in times of stress was to differentiate retail money funds from institutional money funds. For retail funds, the historic $1.00 net asset value (NAV) structure will remain, and investors can count on the value of their funds being $1.00. Institutional funds, however, will be required to let their price float daily, in an attempt to be transparent and let fund prices reflect the prices of the underlying investments. In theory, a floating-rate NAV gives sophisticated institutional investors ample opportunity to review fund holdings and make decisions as to whether they want to exit without causing a “run” on liquidity. There is no telling if this will actually be the case in times of financial stress, but this is the theory.
In addition to the aforementioned floating NAV, institutional money fund managers will be required to keep 30% of their portfolios in investments maturing within 7 business days. If this liquidity “buffer” falls below the 30% floor and the fund is deemed by regulators to be under stress, the fund’s board of directors can begin charging investors for removing their cash at a rate of up to 4%. Finally, if even these actions aren’t sufficient to stem withdrawals, the board may prohibit withdrawals for up to 7 days, and repeat the halt every 90 days until redemptions return to normal. Retail funds, on the other hand, can only request a halt to redemptions, but not require one by prospectus.
Looking ahead, we believe the additional headaches which the new rules create for institutional investors may cause many to simply exit the product. As a money manager, if for many years you’ve been able to count on redeeming your money fund investments at $1.00, with very little risk of loss and immediate liquidity, the new rules are a whole new ballgame, and not a fun one at that. If investors can’t count these investments as cash, and they may not have access to them when they need them most, what good are they? Many institutional investors are therefore likely to drop the product altogether, and move to a government-only money fund, or invest their cash themselves, directly in U.S. Treasury bills. Thus the ultimate effect of these rules could be to further fuel demand for U.S. government debt, while reducing the demand for private credit.
The information contained herein has been obtained from sources believed to be reliable, but the accuracy of the information cannot be guaranteed. The opinions and portfolio information provided in this issue of Capital Ideas are subject to change at any time, and are not to be construed as advice for any individual or as an offer or solicitation of an offer for purchase or sale of any security. Any reference to specific securities or sectors should not be considered research or investment recommendations by Fort Pitt. Past performance is not a guarantee of future performance. The portfolio holdings described are current as of the date of this publication, represent the top 20 holdings held in Fort Pitt’s managed stock strategy and are subject to change. Individual holdings may vary.
Fort Pitt Capital Group is an investment advisor registered with the United States Securities and Exchange Commission (“SEC”). For a detailed discussion of Fort Pitt and its investment advisory fees see the firm’s Form ADV Part 1 and 2A on file with the SEC at www.adviserinfo.sec.gov.