Don't mourn the stable $1-per-share money-market mutual fund just yet.
Firms including Federated Investors Inc. are suggesting that fund companies can avoid new U.S. Securities and Exchange Commission (SEC) requirements to show share-price variations by limiting holdings to very short-term corporate debt.
Fund sponsors warned after the SEC adopted rules for institutional prime funds that a floating price would put off corporations that use the products to manage billions in spare cash. Two months later, Joseph Lynagh, head of money markets and short cash funds at Baltimore-based T. Rowe Price Group Inc., is saying some fund companies will absolutely roll out products to take advantage of the loophole. T. Rowe Price, he said, isn't planning any such products.
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"You may see stuff engineered that camps out on that border," said Peter Crane, president of money-market researcher Crane Data LLC. "There could be a market for it."
Regulators have worked for years on rules to reduce the risk that money funds pose to the financial system. Investors treat them like bank accounts, pulling cash at the first sign of losses. When funds have to meet a wave of redemptions, they can be forced to sell assets at a loss and withdraw from purchasing new short-term corporate debt.
That's what happened in September 2008, after the $62.5 billion Reserve Primary Fund "broke the buck" because of losses on Lehman Brothers Holdings Inc. debt. Its move to reprice its shares below $1 caused panic among investors, who pulled $310 billion from money funds in a single week, which helped freeze credit markets.
Under the SEC rules adopted in July, institutional prime funds—which cater to large investors and purchase corporate debt—have two years to switch to floating-share prices. That could lead large investors needing stable-priced cash-management funds to switch to ones that only hold U.S. government debt.
U.S. money funds manage $2.6 trillion. About $962 billion of that is held in prime institutional funds, according to data compiled by research firm iMoneyNet in Westborough, Massachusetts.
One aspect of the rules received little public notice. It left intact a longstanding provision that mutual funds can value debt that matures within 60 days at original cost, instead of at market prices. As a result, a fund invested exclusively in 60-day debt probably wouldn't see its share price vary from $1.
New Significance
The exemption "has always been there, but now it takes on significance," said Jay Baris, chairman of law firm Morrison & Foerster LLP's investment management practice. "Now, if you are an institutional fund and you want to maintain a steady net-asset value, you can do it provided all your portfolio securities are under 60 days."
While limiting a fund to shorter debt maturities makes it safer, a 60-day cutoff wouldn't have saved the Reserve Primary Fund. Most of the $785 million of Lehman debt it held when the bank failed was within 60 days of maturing.
In a statement, the SEC said its rules require that funds monitor pricing and ensure it doesn't deviate from market values. Events such as sudden interest-rate changes and credit-rating downgrades could affect the value of a fund's holdings enough that its share price deviates from $1.
"The guidance makes clear that an institutional prime money-market fund can only value portfolio securities at cost when that is approximately the same as the market-based price," SEC Investment Management Director Norm Champ said.
Limiting investments to debt that matures in 60 days or less would require funds to give up the higher return earned by longer-term investments. With rates low, many funds use a "barbell" strategy balancing very short-term investments with longer-term debt that earns a higher yield, Crane said. The weighted average life of all prime money funds is currently 78 days, according to the Investment Company Institute, the lobbying group for mutual funds.
"They have got to get out there and do six-month trades just to get some yield," Crane said.
ICI and asset manager Invesco Ltd. urged the SEC last year to preserve the treatment of 60-day holdings.
Some prime funds already operate with short maturities. Invesco's STIC Prime Portfolio, which manages $2.8 billion, only invests in securities that mature in 60 days or less. In periods with interest rates higher than today's, the fund will "tend to have a better yield than Treasury and agency funds" though not as high as a fund that holds securities with the maximum maturity of 397 days, said Bill Hensel, an Invesco spokesman.
More Attractive
Chris Donahue, chief executive officer at Pittsburgh-based Federated, which manages $240 billion in money-fund assets, doesn't offer such a fund. He said the product might grow more attractive in coming years.
"In a different rate environment, that would work," Donahue said during a July 25 earnings call. "And its economics would be very comparable to the current fund."
Meghan McAndrew, a Federated spokeswoman, declined to say whether the company would introduce such a fund. "We have a variety of potential products that we are exploring, but can't go into specifics about any one of them at this point in time," she said in an e-mail.
The returns money funds currently earn investing in short-term debt have plunged so low that funds have been forced to waive some of the fees they normally charge to keep returns above zero.
Corporations that park cash in money funds will eventually divide it into ones maintaining a stable $1 share price and those whose share prices float but earn a higher yield by investing in riskier corporate debt, Lynagh said.
"This is where the industry will begin to differentiate itself," he said.
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