With less than two months remaining before new investor safeguards kick in, the $2.7 trillion money-market fund industry is becoming a radically altered landscape.
In an effort to prepare for the Securities and Exchange Commission's Oct. 14 rule changes that will introduce special fees and redemption restrictions, as well as a floating net asset value for some money funds, it has become a state of “money in motion,” according to Peter Crane, president of Crane Data.
With more than $500 billion having shifted from the affected prime-category money funds into money funds that invest exclusively in government bonds, the total assets in prime money funds dropped below $1 trillion for the first time in 17 years.
“We're seeing a massive shift from prime funds to government funds, but underneath it all we're seeing the big sort,” Mr. Crane said, describing the general effort by asset managers to move assets out of prime money funds and into government funds.
When the money fund rule was passed in 2010, much of the focus was on the requirement that funds investing in anything but government bonds would have to let the net asset value price float, as opposed to the current policy of holding it steady at $1.
Leading up to the official floating NAV requirement, prime funds have been required to publish their NAV on a daily basis.
What investors are seeing has been barely visible fluctuations of factions of basis points above and below the $1 target share price.
Market watchers say that NAV price volatility could increase during periods of extreme market stress or if interest rates move higher, but for now the floating NAV is not seen as the major driver behind the massive asset migration toward government funds.
“Most of the money that has moved so far has been money that the fund companies have converted from prime funds to government funds, largely through changing the default option on sweep products at brokerage firms,” said Jerry Klein, head of the corporate cash management group at HighTower Treasury Partners.
“If they can avoid it, the fund companies don't want to use a money fund that could be subject to exit gates and redemption fees,” he added.
In essence, while the once-radical idea of a floating NAV for certain money-market funds got most of the attention, the bigger concern has become the special redemption fees and liquidity restrictions.
When the new rules kick in, all non-government money funds will have the option of imposing 2% redemption fees if a fund's weekly liquid assets drop below 30% of total assets.
Those non-government money funds will be required to charge a 1% redemption fee when weekly liquid assets drop below 10% of total fund assets.
Under certain circumstances, non-government money funds will also be able to suspend redemptions.
The new rules, which were a regulatory reaction to the fallout from the 2008 financial crisis that saw the Primary Reserve Fund's NAV fall below $1, are designed to prevent investors from running for the exits in a panic.
The rules largely target institutional money-market funds that invest in non-government securities, which is becoming a smaller piece of the market thanks to the efforts by fund companies to shut down prime funds.
According to Sagar Patel, a senior content specialist at Morningstar, the number of prime money funds has dropped from around 500 prior to the law to 460 today. And he expects more prime funds to be shuttered.
“In some cases, it just might be costlier for fund companies to comply with the new rules,” he said. “We won't see the full shakeout until we get closer to October.”
Mr. Crane said, until recently, the prime fund shrinkage has been driven by fund companies moving money into government funds, but he expects the prime fund space to continue shrinking as we get closer to October and institutional investors start pulling more money out.
“We've already seen $500 billion come out of prime funds since October,” he said. “I think we could see another $500 billion move out in the next few months.”
Even though prime funds generally pay a yield premium of about 25 basis points over government funds, that difference isn't considered enough of a spread to derail the direction of asset flows out of prime funds, Mr. Crane said.
“People have speculated that the spread could get to 50 basis points if interest rates start to rise,” he said. “But for now, convenience is king when it comes to cash.”