What Fiduciaries Should Know About Money Market Reform

Money Market Reform: What Fiduciaries Need to Know

For more than 40 years investors have used money market funds reliably to manage their short-term cash and liquidity needs. Money market vehicles typically have been the most common way to manage short-term funds.

In October 2016, however, the SEC implemented some dramatic changes to these funds as a result of the 2008 financial crisis. The changes were designed to protect investors in the event of extreme market volatility and financial stress. Some can affect how these funds have been used traditionally.

As we review the changes it’s important for fiduciaries and other investors to consider how they impact your ability to manage account liquidity and, perhaps even more importantly, to protect and preserve an estate’s value going forward.

Prime funds, once the most common type of money market vehicle, are mutual funds that invest in a very specific and limited set of high-quality, low-volatility financial instruments that the SEC has approved for their use.

Prime Money Market Funds

Liquidity

Possible redemption gate
Funds may be restricted for up to ten business days in a 90-day period

Fees

Withdrawing funds during a redemption gate can incur a fee of up to 2 percent

Yields

Yields frequently are lower than other options

Investment Costs

Internal expense ratios range from 0.20 percent to 0.35 percent

Taxes

Most likely taxed at federal, state and local levels

Underlying Holdings

May include short-term CDs from FDIC-insured banks, government debt, and more

Net Asset Value No Longer Guaranteed

One big change is that the net asset value, or NAV, that is assigned to money market shares now floats based on the total amount of investor assets held in the mutual fund. This is a significant change from the way money market NAV used to be calculated, when it was locked at $1 per share. Today, you’re no longer guaranteed $1 per share, and on any given day a fund’s NAV may be worth more or less than this.

Another important change affecting investors, including fiduciaries, is the introduction of liquidity fees and gates that make money market funds slightly less manageable and convenient than they were prior to 2016.

What are the fees and gates and how do they impact fiduciaries? Let’s take a look.

Fees Increase Costs: Gates Reduce Liquidity

Let’s say you have a thousand dollars in your prime money market fund and you want to write a check for a thousand dollars. Due to the overall mutual fund’s balance, which happens to be lower than normal due to an adverse market event that occurred during the week of this example, your financial institution decides to hold the check for up to 10 days. This is the gate. It’s designed to prevent a run on the fund, or heavy redemptions that jeopardize the mutual fund’s solvency. In this case, your financial institution has the authority to hang onto the check for as many as 10 days, and this obviously affects its liquidity – especially when you need the money this week.

You also learn that you’re going to be charged a fee of as much as 2 percent to write the check, which means your $1,000 check could now cost you $1,020. This also is designed to prevent heavy redemptions and a financial institution can apply the fee during a time of economic stress, when the mutual fund’s weekly liquid assets fall below 30 percent of its total assets. Of course, you may not be aware of this until you actually write the check.

There are alternatives to prime money market funds, including government and municipal money-market funds, short-term certificates of deposit from FDIC-insured banks, government debt, and more. These other types of vehicles can provide greater liquidity, with fewer gates and fees, and some even deliver a higher rate of return than prime funds.

Consider Expenses and Tax Implications:

Here are some other factors to consider as you evaluate short-term cash needs for your estate.

The cost of owning shares in a prime money market fund can be relatively high, often with an expense ratio ranging from 0.20 percent to as much as 0.35 percent. By contrast, other types of passively managed fixed-income instruments may charge only .05 percent or .07 percent, or less. Viewed in this light, a prime money market fund can be four to seven times more expensive, or even more, than other options.

Additionally, prime money market funds aren’t always the most tax-efficient choice. Interest earned in a prime fund can be taxable. While some government and municipal money markets aren’t subject to federal or state taxes, other vehicles exist that may even be better suited to managing taxes within an estate.

While prime funds are considered reasonably safe and low volatility, they aren’t perfect. Other investment options provide FDIC insurance or may be guaranteed by an agency of the federal government, which are even safer.

Finally, the rate of return in a prime money market fund may not be as competitive as other investment choices. If you’re looking to compound the returns in your estate account, you may want to consider other options that offer potentially higher rates of return in exchange for more risk and reduced liquidity.

How to Get Answers to Your Cash Management Questions

If any of these issues concern you, Court Investment Services can recommend some prudent alternatives for estate fiduciaries. It’s one of our core lines of expertise.

We’ll help you learn more about how you can earn an attractive rate of return, while avoiding the downside liquidity and redemption implications of 2016 money market reform.

How CIS Can Help