Fund Fight: Should Value of Money Fund Shares Float?

Three big-name mutual fund shops, including Fidelity Management & Research Company, State Street Corporation and Federated Investors, are warning the Securities & Exchange Commission that eliminating the fixed $1 price of fund shares will scare away many investors who want some minimum level of value stability in their assets.

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Meanwhile, a co-founder of BlackRock said Friday that money market mutual funds would survive, if their asset values would allowed to float from their historical $1 net asset value per share.

"We think there will be some shrinkage, but we don't think it would eliminate the product," Barbara Novick, the vice chairman of the world’s largest asset manager, told Bloomberg News in a telephone interview.

The company, which had opposed the idea, published a report Friday outlining how regulators could make a floating net- asset value, or NAV, acceptable to investors and managers.

The fund industry’s leading trade group, the Investment Company Institute, has rejected the floating NAV idea, saying it would destroy the $2.6 trillion industry. And the three big mutual fund firms, Fidelity, State Street and Federated, argue that the SEC has done enough already, since 2008, to reform the money market fund business and put it on stable footing, long-term.

But in SEC chairman Mary L. Schapiro’s mind, the money market fund business still is “living on borrowed time.”

Meaning: Change is coming soon. Because it is already late.

Her point of reference: September 2008, of course, when the Reserve Primary Fund – the nation’s oldest money market fund – saw the value of its assets fall below the fabled $1 a share that is the bedrock of the industry.

“When the Reserve Primary Fund broke the buck in 2008, it set off a run so serious that the federal government was forced to step in and guarantee the multi-trillion dollar industry,’’ she told the Practising Law Institute in Washington, D.C., on February 24. “It was a shock that reverberated across the market and compelled us to take action.”

That action two years ago meant adopting regulations making the mix of investments money market funds can hold less risky. But now comes the proposal, widely expected and foreshadowed by Schapiro herself, that money market funds should routinely “break the buck.” That is to say, the value of the shares in a money market fund should be allowed to float. That they can strive to fix themselves at a dollar a share at the end of every day. But they would not be required to.

That, Schapiro says, will be more realistic. Investors should know that the value of assets in such funds do in fact fluctuate and their values have to reflect “a sudden deterioration in the quality of holdings,’’ should that occur.

“The fact is investors have been given a false sense of security by money market fund sponsor support and the one-time Treasury guarantee,’’ in 2008 that shared up the industry against the run itt experienced, she said. But “funds remain vulnerable to the reality that a single money market fund breaking of the buck could trigger a broad and destabilizing run.”

Unlike 2008, there will be no Exchange Stabilization Fund the next time to stop the run. Congress eliminated that option when it passed the Troubled Asset Reccovery Program legislation during the credit crisis.

“Today, the money-market fund industry and, by extension, the short-term credit market, is working without a net,’’ she said.

As an alternative, the SEC also is likely to propose that funds have capital requirements, like banks, that provide a buffer against runs on funds. The softener: such buffers would be combined with limitations or fees on redemptions of shares.

“It’s hard to miss the hue and cry being raised by the industry against either of these approaches,’’ she said.

But not all parts of the fund industry are screaming.

Michael W. Roberge, President and Chief Investment Officer at MFS Investment Management, said at the 2012 NICSA Annual Conference that wouldn’t necessarily be bad.

The net asset value would “float so little’’ that it wouldn’t matter to the retail investor, he said.

And retail investors do not dominate money market fund investing. As of the start of February, $926.5 billion was held in retail money market mutual funds, according to Investment Company Institute statistics. By comparison, $1.7 trillion was held by institutions.

That money should go into bank accounts, any way, Roberge argued. Deposits have some federal guarantees and otherwise should be held directly by banks, any way.

Indeed, the SEC “should celebrate that the Reserve Primary fund broke the buck” in 2008, when the value of Lehman Brothers assets it held fell dramatically, said Michael J. Niedermeyer, Chief Executive Officer of the Asset Management Group at Wells Fargo & Company.

That would make it clear that the values of assets in money market funds do change, he said. And investors of all types are better off knowing that and acting accordingly.

If it’s clear that the values of assets fluctuate and the SEC allows the net asset value to float, investors can make clearer comparisons between funds. And opt to buy into funds based on whether the sponsor will back the assets up, in the event of a run, or not, Niedermeyer said.

But the Investment Company Institute, which represents operators of money market mutual funds, is not so sanguine.

In its book, a stable net asset value, where the value of a share of a money market fund is always $1, has benefits to investors.

To wit, in ICI’s book:

• Tax events are avoided. If money market funds had a floating net asset value, it points out, all share sales would become events that have to be reported to the Internal Revenue Service.

• Accounting is simple. Money market funds that keep shares at a stable value of $1 a share qualify as “cash equivalents” under accounting standards. This means there is no need for investors to recognize gains or losses for financial accounting purposes.

With a floating NAV, companies and other organizations would have to:

• Regularly “mark to market’’ the value of their money market fund shares;

• Track the costs of their shares; and

• Determine how to match purchases and redemptions for purposes of calculating gains and losses for accounting and tax purposes.

Features can be rich, with the existing rules, ICI maintains. Without a stable net asset value, broker-dealers could not offer their retail investors a range of features including:

• ATM access;

• Check writing;

• Clearing house and other wire transfers; and

• Same-day settlement on shares redeemed via wire transfers.

A floating net asset value “will undermine the core features of money market funds that investors seek—stability, liquidity, and convenience,’’ contends ICI’s chief executive Paul Schott Stevens. “They will drive retail investors back to the fixed, low rates paid by banks…institutional investors to less regulated, higher-risk alternatives…and fund companies out of the business.’’

Individual investors who write checks on their money market funds want to know that their shares are worth $1.00, he maintains. If their share values floated, they’d lose that benefit—and they would have to treat every money market fund transaction as a taxable event, a huge accounting and tax headache.

Institutional investors would face the same problems. Moreover, many institutional investors are required to put their cash in stable-value accounts. They would avoid funds with floating values, he maintains.

And capital buffers?

.”The cost of building or paying for capital buffers would come from investors’ yields—yields that have been near zero for more than 30 months,’’ he said.

That, too, would be, if not a killer, at least a non-starter.

“Indeed, corporations are allowed to carry these funds as cash equivalent investments without having to track and report on the daily fluctuations in the value of their portfolio.,’’ according to a white paper by Institutional Cash Distributors, a firm which offers offshore money funds to corporations domiciled in Europe. “Were the funds to change to a floating NAV, corporations would have to begin monitoring their mark to market value and report on any minute gains or losses. Though these movements may be extremely small they would still be existent and, absent a significant overhaul of the general accounting standards, these slight gains and losses would have to be reported. “

That means, ICD says, that money in money market funds could and would move outside the United States. “For corporate investors looking to preserve this accounting treatment, the other alternative would be to pursue Money Market Funds offshore, outside of the jurisdiction of the SEC,’’ it said in February. “The offshore fund market has experienced fairly consistent growth over the past few years; a trend that would continue and indeed accelerate if U.S.-based investors can no longer find the right investment products domestically. ‘’

In comment letters to the President’s Working Group Report on Money Market Fund Reform, Fidelity, State Street and Federated fund executives said that the past reforms accomplished a lot in reducing risk and increasing transparency amongst mutual funds, and that these changes will greatly reduce any temptations amongst shareholders to bolt from the funds.

They warned further changes could undermine whatever gains the original amendments made in restoring shareholder trust.

“Contrary to recent comments by some that mutual funds are living on borrowed time, we strongly believe that additional regulation of money market funds is neither necessary nor desirable,” wrote Scott Goebel, senior vice president and general counsel of Fidelity Management & Research Company, in a March 1st letter to the securities agency.

Attorney John Hawke, a partner in the firm Arnold & Porter, wrote a letter on behalf of Federated Investors arguing that same-day settlement of a transaction is a crucial feature of mutual funds that is crucial to their market attractiveness. The holdback will “destroy” the ability of companies and individuals to use the funds as a liquid investment that can be readily redeployed the same day.

A capital reserve, Hawke wrote further, might not impact mutual fund yields on a day-to-day basis, but its presence would inevitably decrease yield from time-to-time.

The SEC and members of Congress continue to hold public talks related to the proposals. Members of Industry observers expect that regulatory language articulating the changes should be hashed out by the end of the second quarter. After that the five commissioners of the SEC will have to vote to adopt them.

Tom Steinert-Threlkeld writes for Securities Technology Monitor.

—Tommy Fernandez contributed to this report