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.