For a harrowing three days in September 2008, financial advisers could only wonder, “What next?” after the Reserve Primary Fund fund broke the buck.
Though some of us think those days are behind us, regulators haven't forgotten, and neither has the public, according to a recent Washington Post-ABC News poll in which the majority of those surveyed said that they don't think that Wall Street and Washington have done enough to avoid another financial crisis.
On Sept. 18, the House Capital Markets Subcommittee revisited the issue in light of the Securities and Exchange Commission's long-delayed plans to stop a threatening run on money market mutual funds by floating the net asset value for institutional funds or, alternatively, charging a 2% redemption fee and imposing a 30-day “gate” on redemptions by retail investors in stable-NAV ($1 a share) funds.
Former Federal Deposit Insurance Corp. chairman Sheila Bair, now chairman of the Systemic Risk Council, was almost the lone voice on a witness panel of industry experts reminding the House panel that the Federal Reserve won't be able to bail out money market funds in the next crisis as it did in the last one.
She also argued that not moving to a floating NAV for all money market funds would disrupt the short-term market in a variety of ways and, more importantly, not accomplish the primary goal of stopping a rush to the doors by panicked retail investors.
For example, an SEC study of the fund crisis indicated that the primary source of the panic after the Reserve Primary Fund dropped to 97 cents a share was institutional investors, who cashed in nearly 14% of all money market assets in less than 72 hours. Ms. Bair was troubled by the proposal to discourage a rush by retail investors through a combination of redemption fees and gates, because enhanced disclosure of fund holdings to the public may help investors “understand how to game money funds by running, but [the disclosures] will not eliminate the structural weakness that causes runs, nor the systemic risks that can follow.”
Furthermore, she said that the proposed SEC rule would allow up to 20% of assets in government money market funds to be invested in commercial paper, and “whatever "derisking' comes from moving the stable NAV to government/agency assets would be lost as money funds use this 20% "other' bucket to reach for yield.”
A floating NAV, by contrast, is the “same, simple regulatory framework that applies to all other mutual funds,” Ms. Bair said in urging its adoption.
Furthermore, she emphasized that a floating NAV is “a framework that the SEC has implemented successfully [and without systemic risk or taxpayer bailouts] since 1940.”
It is important to put this debate in perspective, given the critical importance of money market funds as an asset class. After first considering the client's investment time horizon, fiduciaries need to be aware of the client's liquidity needs.
Even the Financial Industry Regulatory Authority Inc. recognized the importance of time horizon and liquidity needs last year in its revised suitability rule for nonfiduciary brokers.
Therefore, advisers should monitor this debate and the adoption of a revised rule by the SEC in order to assess the potential risks of this once-backwater asset class.
There are some questions that advisers may want to ask themselves and clients:
• Has the change in rules governing money funds increased the risk of loss in the event of a “black swan” event?
• Will the change in money fund rules affect clients' appetite for risk?
• In the event that a gate-and-penalty solution is adopted by the SEC — one that restricts access to money funds — do clients have a backup plan to address their short-term liquidity needs?
• Do advisers need to revisit the investment policy statements with clients that address asset class selection, including any covering investment options in qualified plans?
• And finally, do clients really understand that money funds aren't guaranteed by the federal government, as are bank deposits?
The debate over the stability of money market funds highlights this important fiduciary obligation to act in clients' best interests. In fiduciary terms, this translates into establishing a consistent process to ensure that all investment recommendations are suitable, even when the recommendation involves a product as seemingly benign as a money market fund.
Blaine F. Aikin is president and chief executive of fi360 Inc.