Money-market mutual funds used to be boring and simply a place to park your excess cash temporarily. But new rules passed by the Securities and Exchange Commission governing the $2.7 trillion industry take effect in October 2016. As a result, investors used to ignoring that part of their portfolio might suddenly have to pay attention instead and make some informed choices. The SEC regulations aim to prevent an investor exodus from money-market funds like the one that happened during the 2008 financial crisis, when the federal government had to step in with financial backing for the industry.
One requirement under the new rules is that the shares of money-market funds that cater to institutional investors and invest in corporate or municipal debt will have a floating net asset value or NAV, like the shares of most other mutual funds. That’s a change from the stable $1-a-share value traditionally maintained by all money-market funds. The idea is that investors will be aware of changes in asset values as they occur and be able to adjust their holdings accordingly, rather than stampeding out of funds when they suddenly become aware that their shares aren’t worth $1. We believe that even though money-market fund NAV’s for institutional accounts will be allowed to float; the change in value away from the traditional $1 will be very minor.
Another big change is that all money-market funds that invest in corporate or municipal debt will be allowed to charge investors a fee to redeem shares when the funds are under pressure or temporarily block investors from withdrawing cash. But it would take a very adverse market reaction to trigger these provisions. For money-market funds that invest in only government securities, which include agency debt, these rules won’t apply.
Here are some of the basics as to what investors need to know regarding the new rules:
Types of Money-Market Funds
Money funds can be divided into three categories according to their investments: prime funds, which can invest in short-term corporate debt to generate potentially higher yields; government funds, which invest in U.S. government and federal agency debt; and municipal funds, which invest in the debt of state and local governments and will typically generate tax-free income at either the federal or state level, or in some cases both.
Classification of Funds Between Retail and Institutional
The new rules will create another distinction, currently money-market funds will co-mingle the money of institutional and individual, or retail, investors. But because the new rules make a distinction between institutional and retail investors, fund companies will now have to separate institutional and retail funds.
The following types of accounts will qualify as retail accounts:
◾ Revocable Personal Trusts
◾ Irrevocable Personal Trusts with an Individual Serving as Co-Trustee
◾ Regular Investment Management Accounts Tied to an Individual
◾ IRA’s, SEP’s, and Keogh Plans
◾ Defined Contribution Plans such as 401(k) Plans, 403(b) Plans and 457 Plans
The following types of accounts will qualify as institutional accounts:
◾ Irrevocable Personal Trusts with a Bank as the Sole Trustee
◾ Non-Profit Accounts such as Foundations and Endowments
◾ Defined Benefit Plans
◾ Custody Accounts for Corporations, Municipalities and Insurance Companies
◾ Corporate Trust Accounts
◾ Escrow Accounts
Understanding the difference between retail accounts and institutional accounts is important because institutional funds will have a floating NAV if it is not a government money-market fund. All retail funds will maintain a stable NAV regardless of the type of fund.
In recent years, money-market funds have not provided much yield with prime type funds having the highest yields because of their flexibility to invest in short term corporate securities while government and municipal funds typically yield less. This won’t change under the new rules and the spread between prime fund yields and government funds could widen further as many investors migrate to government funds because of their stable NAV and less restrictions on redemptions.
Thus investors will have to make a choice. Should they invest in a prime fund that could earn a little more but is more risky and thus subject to redemption fees and temporary withdrawal restrictions or for the case of an institutional investor, a floating NAV, or put money in a safer fund that will probably yield less, but offers greater peace of mind?
For all of our First Bank Wealth Management accounts, including 401(k) accounts, we plan on migrating to the new money market funds by October 1 and our new standard default option will be the Federated Government Obligations Fund, which is a government money-market fund, thus not subject to redemption fees, withdrawal restrictions or have a floating rate NAV. However, if anyone has any questions or would like to discuss with us using a different money market fund, please reach out to your portfolio manager, relationship manager or account administrator and we can review your options in more detail.
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