Fri09192014

Business & Real Estate

Does recent SEC action make money market funds riskier?

Editor’s note: This is the first in a two-part series on money market funds.

The Securities and Exchange Commission (SEC) voted July 23 to impose new rules on money market funds aimed at preventing mass selling during financial panics. The most significant change was the elimination of the fixed $1 share price for certain types of funds.

“Today’s reforms fundamentally change the way that money market funds operate,” said SEC Chairwoman Mary Jo White.

Do these changes make money market funds more risky? Is this a good time to bail out of them in favor of other types of investments? In this article, I’ll cover the background of these changes. In a subsequent article, I’ll address the above questions.

Money market history

To put this in perspective, a money market fund is a type of mutual fund developed in the 1970s as a way for investors to get higher returns than interest-bearing bank accounts by purchasing a pool of very short-term securities. What’s unique about money market funds is their ability – thanks to a provision in the 1940 Investment Company Act allowing such funds to value their investments at amortized cost rather than at market value – to maintain a constant $1 per share net asset value (NAV). This feature has made money market funds extremely popular, helping them collectively to grow to nearly $3 trillion today.

However, there have been occasions when a money market fund was unable to maintain a $1 NAV. The first such fund to “break the buck,” as it’s known, was First Multifund for Daily Income (FMDI) in 1978. FMDI was technically not a money market fund because the managers violated their own strategy of investing in short-term (30- to 90-day) money market obligations when they started buying increasingly longer-maturity securities to try to drive up returns. Nonetheless, the fund was forced to restate its NAV to 94 cents when interest rates unexpectedly soared, costing its investors 6 percent on their holdings.

In 1994, The Community Bankers US Government Fund broke the buck, paying investors only 96 cents per share. In this case, the fund used risky derivatives to try to generate higher returns and, as with FMDI, got caught when interest rates rose. Because the fund’s depositors were mostly banks, no consumers were impacted (at least directly).

The only other failure in the then-37-year history of money funds occurred in 2008, when Reserve Primary, which had been heavily invested in Lehman Brothers’ debt, was forced to restate its NAV to 97 cents after Lehman went bankrupt. (One might be somewhat sympathetic to Reserve Primary when you consider that the Leh- man debt had been rated as AAA quality just a few days before the bankruptcy.)

Primarily as a result of the Reserve Primary failure, the SEC has been working on a way to avoid this problem in the future. After five long years of discussion and debate, they’ve come up with some significant rule changes designed to reduce shareholders’ incentive to make mass withdrawals by forcing money fund prices to more accurately reflect their actual values. Note that the SEC vote was close (3-2), with some members concerned that the new rules would actually have the opposite effect.

In the next article, I’ll cover the changes in more detail and address whether money market funds are still worthwhile investments.

Los Altos resident Artie Green is a Certified Financial Planner and principal at Cognizant Wealth Advisors. For more information, call 209-4062 or email This email address is being protected from spambots. You need JavaScript enabled to view it. .

Schools »

Schools
Read More

Sports »

sports
Read More

People »

people
Read More

Special Sections »

Special Sections
Read More

Photos of Los Altos

photoshelter
Browse and buy photos