T

he Securities and Exchange Commission on Wednesday voted unanimously to propose long-awaited reforms for money market funds (MMF).

The first proposal would affect prime institutional money market funds, which are allowed to take on credit risk and account for about $826 billion in assets. They would be required to convert from a fixed, $1 par net asset value (NAV) to a floating net asset value (FNAV) share price.

Under the second proposal, MMFs may be required to impose liquidity fees and gates on redemptions during times of severe market stress. (Government MMFs, which invest primarily in government securities, would not be subject to these new regulations.)

The SEC is seeking public comment on whether one or both of these proposals should be adopted. In addition, the SEC outlined several other possible enhancements to MMFs, such as increased diversification and disclosure policies.

PIMCO views this vote as a pivot point for cash and liquidity management. Approximately 40 years ago, the emergence of regulated 2a-7 money market funds caused a shift in liquidity management; monies intended for short-term savings migrated away from traditional bank-managed accounts into MMFs, which offered a stable NAV and attractive yields.

Now, we expect a shift away from the 2a-7 dominated $1 par NAV regime. In our view, actively managed short-term fixed income strategies will become increasingly important for liquidity management.

Prime MMF investors will have time to prepare during the 90-day public comment period, which will be followed by a review period and then a final announcement and implementation. These changes won’t be finalized for several months – if not more – and could take years to be implemented.

Nevertheless, a potential change has just begun. We are not saying that the demise of prime 2a-7 funds is imminent or even likely. Rather, we are simply highlighting that other compelling complements for liquidity management are available for investors to consider in response to these regulatory changes.

Here are some key questions and answers:

Why are new regulatory proposals for 2a-7 funds under consideration?
In 2010, new rules were imposed on money market funds in response to the Reserve Primary Fund having broken the buck in 2008. However, many regulators felt that further reform was necessary to offset the risk that MMFs might still be susceptible to runs on assets, particularly prime institutional MMFs.

How might these changes impact MMF and cash management investors?
Returns in money market funds continue to remain close to 0%, net of fees, without much potential for an increase in the foreseeable future given the expected continuation of the Fed’s accommodative policies. Under the current fixed NAV regime, prime MMFs represent an asset with no volatility and almost no yield (three basis points on average).

Under the SEC’s first proposed rule, prime funds will face a structural shift to a floating NAV. Thus, the daily NAV of these funds will likely exhibit some volatility, yet we do not expect any substantial increase in yield in the near-to-medium term. In short, with the altered risk-reward tradeoff, investors will need to consider whether using prime MMFs for cash management will remain as attractive as before if the first proposal is adopted.

If the SEC’s second proposal is adopted, investors across both institutional and retail prime MMFs could potentially face fees and gates on their redemptions during times of severe market stress, or when a fund’s weekly liquid assets drop below 15% of its total assets. A retail fund would be defined as a fund that limits redemptions to $1 million per shareholder per day.

Although we recognize that the SEC intends these proposed reforms to reduce systemic risk and the risk of runs, we believe that investors need to consider other options for liquidity-oriented portfolios. In fact, while perhaps seemingly novel, many prime MMF alternatives – which seek capital preservation and liquidity while balancing risk and reward – have been used routinely and successfully by several money managers for decades.

What are alternative cash management options for MMF investors?
Investors in the $2.6 trillion MMF universe may face a critical decision in the coming months.
It will likely be most pressing for investors in prime institutional MMFs, which would be affected by both proposed rules. We see five main investment options for prime MMF investors should the SEC’s recommendations be adopted:

  • Remain in existing 2a-7 prime MMFs, and tolerate any volatility associated with the FNAV structure.
  • Shift to U.S. Treasury or other government-focused MMFs which remain fixed at $1 par NAV but typically offer lower yields than prime funds.
  • Move funds to bank deposits (insured and uninsured account options).
  • Self-invest in U.S. Treasury bills.
  • Invest in short-term fixed income offerings focusing on capital preservation with, as we see it, more compelling risk and reward profiles than traditional money market funds.

Perhaps the most obvious choice, simply switching from prime funds to government-only MMFs, may not ultimately be the best solution. We estimate that investors could seek that switch with more than $500 billion in assets.  However, the supply of AAA-rated investable assets for these funds to invest their proceeds is shrinking as the U.S. government deficit declines and other issuers opt for longer-term financing in the low interest rate environment. Demand, meanwhile, is rising, in part due to central clearing collateral requirements for derivatives. Both retail and institutional investors could be left out in the cold if the supply-demand dynamic leads sponsors of government-focused MMFs to spurn additional inflows due to more limited investment options.

Given the uncertain outcome of these proposals, most investors will likely wait and react once the SEC’s actions are fully implemented. However, we would urge all investors to recognize this possible change in traditional cash management vehicles and educate themselves on alternative liquidity-management options that offer return opportunities in excess of the near-zero returns that are available within this changing landscape.

Money market reform is upon us and the cash management landscape is changing. Soon we will see how MMF investors react to the next steps in the evolution of cash management.

The Author

Jerome M. Schneider

Head of Short-Term Portfolio Management

View Profile

Latest Insights

Disclosures

Pacific Investment Management Company LLC, 650 Newport Center Drive, Newport Beach, CA 92660 is regulated by the United States Securities and Exchange Commission. | PIMCO Europe Ltd (Company No. 2604517), PIMCO Europe, Ltd Amsterdam Branch (Company No. 24319743), and PIMCO Europe Ltd- Italy (Company No. 07533910969) are authorised and regulated by the Financial Conduct Authority (25 The North Colonnade, Canary Wharf, London E14 5HS) in the UK. The Amsterdam and Italy Branches are additionally regulated by the AFM and CONSOB in accordance with Article 27 of the Italian Consolidated Financial Act, respectively. PIMCO Europe Ltd services and products are available only to professional clients as defined in the Financial Conduct Authority’s Handbook and are not available to individual investors, who should not rely on this communication. | PIMCO Deutschland GmbH(Company No. 192083, Seidlstr. 24-24a, 80335 Munich, Germany) is authorised and regulated by the German Federal Financial Supervisory Authority (BaFin) (Marie- Curie-Str. 24-28, 60439 Frankfurt am Main) in Germany in accordance with Section 32 of the German Banking Act (KWG). The services and products provided by PIMCO Deutschland GmbH are available only to professional clients as defined in Section 31a para. 2 German Securities Trading Act (WpHG). They are not available to individual investors, who should not rely on this communication. | PIMCO (Schweiz) GmbH (registered in Switzerland, Company No. CH-020.4.038.582-2), Brandschenkestrasse 41, 8002 Zurich, Switzerland, Tel: + 41 44 512 49 10. The services and products provided by PIMCO Switzerland GmbH are not available to individual investors, who should not rely on this communication but contact their financial adviser. | PIMCO Asia Pte Ltd (8 Marina View, #30-01, Asia Square Tower 1, Singapore 018960, Registration No. 199804652K) is regulated by the Monetary Authority of Singapore as a holder of a capital markets services licence and an exempt financial adviser. The asset management services and investment products are not available to persons where provision of such services and products is unauthorised. | PIMCO Asia Limited (Suite 2201, 22nd Floor, Two International Finance Centre, No. 8 Finance Street, Central, Hong Kong) is licensed by the Securities and Futures Commission for Types 1, 4 and 9 regulated activities under the Securities and Futures Ordinance. The asset management services and investment products are not available to persons where provision of such services and products is unauthorised. | PIMCO Australia Pty Ltd ABN 54 084 280 508, AFSL 246862 (PIMCO Australia) offers products and services to both wholesale and retail clients as defined in the Corporations Act 2001 (limited to general financial product advice in the case of retail clients). This communication is provided for general information only without taking into account the objectives, financial situation or needs of any particular investors. | PIMCO Japan Ltd (Toranomon Towers Office 18F, 4-1-28, Toranomon, Minato-ku, Tokyo, Japan 105-0001) Financial Instruments Business Registration Number is Director of Kanto Local Finance Bureau (Financial Instruments Firm) No.382. PIMCO Japan Ltd is a member of Japan Investment Advisers Association and The Investment Trusts Association, Japan. Investment management products and services offered by PIMCO Japan Ltd are offered only to persons within its respective jurisdiction, and are not available to persons where provision of such products or services is unauthorized. Valuations of assets will fluctuate based upon prices of securities and values of derivative transactions in the portfolio, market conditions, interest rates, and credit risk, among others. Investments in foreign currency denominated assets will be affected by foreign exchange rates. There is no guarantee that the principal amount of the investment will be preserved, or that a certain return will be realized; the investment could suffer a loss. All profits and losses incur to the investor. The amounts, maximum amounts and calculation methodologies of each type of fee and expense and their total amounts will vary depending on the investment strategy, the status of investment performance, period of management and outstanding balance of assets and thus such fees and expenses cannot be set forth herein. | PIMCO Canada Corp. (199 Bay Street, Suite 2050, Commerce Court Station, P.O. Box 363, Toronto, ON, M5L 1G2) services and products may only be available in certain provinces or territories of Canada and only through dealers authorized for that purpose. | PIMCO Latin America Edifício Internacional Rio Praia do Flamengo, 154 1° andar, Rio de Janeiro – RJ Brasil 22210-906.

Past performance is not a guarantee or a reliable indicator of future results. All investments contain risk and may lose value. Investing in the bond market is subject to certain risks, including market, interest rate, issuer, credit and inflation risk; investments may be worth more or less than the original cost when redeemed. Money Markets are not insured or guaranteed by the FDIC or any other government agency and although they seek to preserve the value of your investment at $1.00 per share, it is possible to lose money. Sovereign securities are generally backed by the issuing government; portfolios that invest in such securities are not guaranteed and will fluctuate in value. The credit quality of a particular security or group of securities does not ensure the stability or safety of the overall portfolio.

Statements concerning financial market trends are based on current market conditions, which will fluctuate. There is no guarantee that these investment strategies will work under all market conditions or are suitable for all investors and each investor should evaluate their ability to invest for the long-term, especially during periods of downturn in the market.

This material contains the opinions of the author but not necessarily those of PIMCO and such opinions are subject to change without notice. This material has been distributed for informational purposes only. Forecasts, estimates, and certain information contained herein are based upon proprietary research and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission. PIMCO and YOUR GLOBAL INVESTMENT AUTHORITY are trademarks or registered trademarks of Allianz Asset Management of America L.P. and Pacific Investment Management Company LLC, respectively, in the United States and throughout the world. ©2013, PIMCO.