Money market reforms force advisers to rethink risk

SEC Chairwoman Mary Jo White said reforms would “fundamentally change” funds. She was right.

Feb 19, 2015 @ 11:56 am

By Trevor Hunnicutt

Financial advisers face choices — and a new trade-off between risk and reward — as money market funds begin to implement changes following rules passed by the Securities and Exchange Commission last year.

Fidelity Investments will ask shareholders in March to approve plans to convert three prime funds, including Fidelity Cash Reserves, into government funds.

The largest money market fund manager said the change will make the $112 billion Fidelity Cash Reserves (FDRXX) more stable in a crisis — government securities are considered virtually risk-free — but such a move is also likely to depress the already-thin yields they pay out to investors.

BlackRock Inc. is considering doing the same for about $3.6 billion in retail prime funds later this year, according to spokeswoman Tara McDonnell. Other managers are widely expected to follow suit.

Money market fund managers are attempting to protect the stable $1 per share quoted to investors, as well as to tamp down fears of managers' preventing withdrawals in times of market stress.

Government-focused funds are exempt from requirements due to go into effect next year that would force them to let their share prices fluctuate and allow them to impose liquidity restrictions.

Nancy D. Prior, president of Fidelity's fixed-income division, said a number of clients insisted on the value of money market funds with stable prices and no liquidity restrictions, but she added that the firm will retain a broad lineup.

But the changes mean advisers will need to rethink their options, from government-focused funds that may deliver rock-bottom yields but continue to operate like the money market funds of old, to corporate and municipal-debt funds that could restrict redemptions and see their share prices float, and ultrashort-term bond funds that can take on more market risk but also deliver richer yields.

For funds that don't convert to government-focused securities — including those invested in municipal securities and corporate debt — a number of questions remain.

By designating the funds “retail,” they can sidestep the requirement to let the fund's net asset value float from $1 per share but at the cost of demonstrating that all the fund's investors are individuals. Managers can also commit to not imposing fees or gates that would discourage or prevent withdrawals.

Fund investors should take into account the cost of possible fees and gates when weighing their investment options, as it could mean less liquidity than a traditional money market fund, an advantage those funds long held over bank-issued certificates of deposit, analysts said.

A number of broker-dealers are avoiding the problem altogether, moving “sweep” assets into bank-deposit programs, which pay returns similar to those on money market funds but are run through broker-dealers' bank affiliates, according to Matthew Yee of Gartland & Mellina Group, a consultant to broker-dealers.

Pimco is among the fund companies courting money market investors and pushing the case that investors should better understand the risks and opportunity cost of money market funds in the new regulatory environment.

The firm is a much smaller presence than its competitors in money market funds, but it manages $35 billion in U.S. short and ultrashort funds.

Some of those products are less-stringently regulated and have the ability to seek values and buy a wider range of products, according to Jerome M. Schneider, head of the short-term and funding desk at Pimco and a listed portfolio manager on funds with $38 billion in assets, including the Pimco Short-Term Fund (PSHAX).

“The money market fund, which [investors have] enjoyed the benefits of for the past 40 years, may not provide the same liquidity and comfort on a go-forward basis,” Mr. Schneider said.


Some advisers agree.

“If you don't need the money today, tomorrow for a specific need, or if you can make up any potential shortfall, then I think you're probably better off using a short-term bond fund to get that extra little bit of yield,” said Jeffrey DeMaso, director of research at Newton, Mass.-based Adviser Investments.

Mr. Schneider also said money market funds invested in corporate debt may not be paying enough to compensate investors for risk or for the liquidity trade-off that will be required in funds that raise gates. And he echoed concerns by Wall Street analysts about the ability of the market for short-term Treasury and federal agency debt to support increased demand from government money market funds.

Ms. Prior of Boston-based Fidelity disagreed, saying the effects of the conversion of her firm's Cash Reserve fund were likely to be muted because of the liquidity in government securities.

A number of other funds have been positioning to capture business from money market funds. Twelve short bond funds have been introduced since last year, when the SEC finalized its reforms.

Valley Forge, Pa.-based Vanguard this month plans to launch its own Ultra-Short-Term Bond Fund (VUBFX).

While the firm said the fund launch was not done “in response to the new SEC money market rules,” according to spokesman David Hoffman, one marketing circular touted the product's ability to offer “better return than the near-zero yield of a money market fund without losing the ability to access your money as you would” with a certificate of deposit.

That language was subsequently removed, and Vanguard added the caveat that the “fund should not be viewed as an alternative to money market funds.”

“Unfortunately, an article was published on one of our sites that did not reflect our strong caveat, but it was quickly corrected,” Mr. Hoffman said. “We have been very clear that the fund is primarily intended for investors seeking to augment the bond component of a balanced portfolio and further diversify duration. We have also been very clear that the new fund will have some risk to principal, and we are cautioning investors that it is not a money market fund substitute.”

Indeed, principal is at risk in this category. The average ultrashort bond fund lost 7.89% of its value in the financial crisis year 2008, according to Morningstar Inc., and some funds dropped by far more.

That was also a tough year for money market funds: Investors fled after the $62.5 billion Reserve Primary Fund, which was invested in Lehman Brothers debt, “broke the buck,” falling below $1 a share when that investment bank collapsed.


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