This fall, on Oct. 14, new Securities and Exchange Commission regulations will upend the longtime practice of institutional asset owners investing cash in money market funds to maintain principal while enjoying daily liquidity and earning a competitive return.
Asset owners will have to re-evaluate their appetite for certain cash investment vehicles.
Under the regulations, institutional prime money market funds, which hold commercial paper and other non-Treasury securities, will have a floating, market-based net asset value, rather than the traditional stable $1 per share net asset value.
In addition, the regulations allow these funds to impose redemption gates and liquidity fees of up to 2% of assets to prevent abrupt outflows from funds in times of severe market stress.
Broadly speaking, the SEC rule changes are intended to increase transparency and the resilience of money market funds during significant market downturns, while also maintaining the many benefits that the funds offer, such as daily liquidity, safety of principal and relatively low risk profiles.
Many asset owners view the rule changes as complex and burdensome and have sought to move their money into more conservative MMFs — basically holding only government securities — which will still offer rapid access to cash and stable net asset values. Or they have sought out alternative vehicles, such as separately managed accounts, ultrashort bond funds and exchange-traded funds. But for others who are willing and able to cope with the new regulations and the operational complexity within institutional prime MMFs, higher potential yields might be on the horizon.
The migration of assets away from prime funds, and into government funds, began after the regulatory changes were announced in 2014. The trend has — not surprisingly — continued to gain steam. Last year, the total net assets in institutional government funds surpassed those in institutional prime funds for the first time in many years. In the weeks between April 27 and Sept. 7, $320.13 billion exited prime and tax-exempt institutional money market funds, while $350.3 billion flowed into institutional government money market funds, according to Investment Company Institute's data. Clearly, sticking around in prime MMFs hasn't been the popular choice for asset owners, but that doesn't decrease their validity as an investment option. Particularly for those in search of additional, albeit incremental, yield.
As assets continue to shift away from prime funds, an interest rate increase by the Federal Open Market Committee will help to widen spreads beyond the roughly 20-basis-point yield advantage prime funds currently offer above government funds. Not a bad reward for asset owners that can cope with the risk and operational complexities associated with new institutional prime fund regulations.
Price of avoiding change
Many asset owners are simply viewing the lower yields offered by government funds as the price of avoiding regulatory change in the cash space. Taking on the added risk associated with floating NAVs, and the potential for liquidity fees and redemption gates and operational challenges cannot be justified in an investment environment characterized by low growth and volatility. Additionally, institutional prime money market funds have had a stable $1 per share NAV using amortized cost accounting, but going forward institutional prime money market funds will have to switch to a floating market-based NAV priced to the fourth decimal place.
While higher yields are the most obvious benefit that corporate treasurers and other asset owners might derive from staying with institutional prime funds post-reform, the funds will also provide intradaily liquidity and up to three-times-per-day pricing. Unlike short-term bond funds, institutional prime MMFs will have a simplified method of accounting. As long as asset owners are comfortable with the idea of floating NAVs — and the very rare possibility of liquidity fees and redemption gates — institutional prime money market funds will continue to offer a solid and safe investment option.
Since the 1980s, prime money market funds have served a vital role as investment vehicles for institutional asset owners and will remain important tools for managing liquidity. And while prime funds may no longer be the ideal solution for all institutions, their appeal for certain institutional asset owners will likely increase as the impact of new regulations comes into focus and the dust settles.
For now though, the question must still be asked: Are the benefits of staying put worth it?
J. Charles Cardona, New York-based president of The Dreyfus Corp. and CEO of BNY Mellon Cash Investment Strategies, a Dreyfus division, oversees short-duration fixed-income activities, including investment management, distribution and client service.