The SEC’s Office of Investor Education and Advocacy recently issued an Investor Bulletin to help educate investors about money market funds, including money market funds’ investment objectives and risks.
Money market funds, sometimes called money funds, are a type of mutual fund that has relatively low risks compared to other mutual funds and most other investments and historically has had lower returns. Money market funds invest in high quality, short-term debt securities and pay dividends that generally reflect short-term interest rates. Many investors use money market funds to store cash or as an alternative to investing in the stock market.
Money market funds, like all mutual funds, are redeemable on demand. This means that investors can generally sell their shares back to a money market fund on any business day at the net asset value or NAV. The NAV is the per-share value of a fund’s assets minus its liabilities. Some types of money market funds – government and retail money market funds – are allowed to try to keep their NAV at a stable $1.00 per share. These funds do this by using special pricing and valuation conventions when valuing the fund assets. Other money market funds –institutional prime money market funds – may not use these special conventions and must float their NAV like other mutual funds. This means that, although these money market funds still try to keep a fairly constant price, they must allow their daily share price (the NAV) to fluctuate with the current market-based value of fund assets. Before buying shares of a money market fund, investors should understand which type of money market fund they are purchasing.
What types of money market funds are there?
There are many kinds of money market funds, including ones that invest primarily in government securities, tax-exempt municipal securities, or corporate and bank debt securities. In addition, money market funds are often structured to cater to different types of investors. Some funds are intended for retail investors, while other funds that typically require high minimum investments are intended for institutional investors. The rules governing money market funds vary based on the type of money market fund.
For example, money market funds that primarily invest in a variety of taxable short-term corporate and bank debt securities are generally referred to as prime funds. Government money market funds are defined as money market funds that invest 99.5% or more of their total assets in very liquid investments, namely, cash, government securities, and/or repurchase agreements that are collateralized fully with government securities. Retail money market funds are defined as money market funds that are generally limited to natural persons. As noted above, government and retail money market funds are permitted to use special pricing and valuation conventions to try and keep their NAV at a stable $1.00 per share, whereas institutional prime money market funds are required to float their NAV like other mutual funds.
What are the risks of investing in money market funds?
As discussed above, on the one hand, government and retail money market funds try to keep their NAV at a constant $1.00 per share using special pricing and valuation conventions. If one of these money market fund’s NAV deviates by more than half a cent from $1.00, the fund would have to re-price its shares to something other than $1.00, which is known as “breaking the buck.” Therefore, if it deviates by more than half a cent below $1.00 (as one money market fund did in 2008 due to losses in the underlying investments), investors in the fund will likely lose money. On the other hand, institutional prime money market funds must allow their NAV to float. As with other mutual fund investments, the value of these fund shares generally decreases or increases as the money market fund assets decrease or increase in value, respectively. If the value of the fund shares decrease, investors in the fund will likely lose money.
The yield of money market funds changes over time and generally reflects changes in short-term interest rates. The yield is income that is distributed to shareholders as dividends which many shareholders reinvest into the money market fund. Historically, the returns for money market funds have been lower than for other types of mutual funds. Moreover, if short-term interest rates are very low, it is possible that fees charged by the fund will exceed the income earned on fund investments, in which case fund investors may face losses. As with any investment, you should consider the impact of fees on your investment.
Because the yield for money market funds can be low, there is also the risk that inflation will outpace and erode investment returns over time.
What tools can money market funds use in times of market stress?
Liquidity Fees and Redemption Gates. In times of market stress, a run on the fund or heavy redemptions can mean that investors that sell early in the run may get more money for their shares at the expense of investors who sell later. To try and keep this from happening, a money market fund’s board of directors can determine to charge fees on redemptions (liquidity fees) and can even suspend redemptions temporarily (redemption gates) in certain circumstances. Although these tools can help stabilize the value of a money market investment in times of market stress, when they are used, the investment would be less liquid. All money market funds except government money market funds are allowed, and sometimes required (unless the board determines otherwise), to use these tools when certain circumstances occur. Government money market funds can voluntarily opt into using these tools when certain circumstances occur, if the ability to do so is disclosed in the fund prospectus.
Permanent Suspension of Redemptions. If certain circumstances occur, money market funds are permitted (but not required) to permanently suspend redemptions and liquidate (or close) the money market fund. This tool is meant to help facilitate an orderly liquidation of the fund.
What is the difference between money market funds and money market depository accounts?
Money market funds are different from money market depository accounts offered by banks and should not be confused with them. Money market depository accounts are guaranteed by the FDIC and therefore the principal in that deposit account is fully protected up to the dollar limits established by law. An investment in a money market fund, however, has no FDIC guarantee.
The foregoing information, which is all publicly available, is being provided by The White Law Group. The White Law Group is a national securities fraud, securities arbitration, and investor protection law firm with offices in Chicago, Illinois and Vero Beach, Florida. For information on the firm please visit www.whitesecuritieslaw.com.
For a free consultation with a securities attorney, please call The White Law Group at 1-888-637-5510.