Fixed Income

Liquidity restrictions haunt money-market funds

As investors hunt for yield and security, money-market fund managers detail their changes.

Some investors demand nothing less than unfettered access to their cash at a stable price. To deliver that, asset managers are increasingly going to be offering them money-market funds that invest almost exclusively in cash and very low-interest, government-secured debt.
Others, looking for money-market funds with potentially richer yields, are going to have to get to know a concept more familiar to hedge fund clients: gates.
BlackRock Inc., the third-largest U.S. money market fund provider, announced Monday in a letter to clients some of its plans for its $218 billion in largely institutional funds. Among the changes affecting mom-and-pop investors: some of the firm’s estimated $22 billion in retail funds invested in corporate debt will convert to government-investing funds. The firm has not said which funds will transition.
The move, which the firm first announced earlier this year, follows similar decisions by other fund companies. Fidelity Investments, for example, is converting three of its prime funds, including the $112 billion Fidelity Cash Reserves (FDRXX).
The changes mean that those converted funds will now primarily invest in short-term government debt, which is considered virtually risk-free. But those securities could also depress the already-thin yields the funds pay out to investors.
The fund managers are attempting to protect the stable $1 per share quoted to investors, as well as to tamp down fears of managers’ preventing withdrawals in times of market stress. Government-focused funds are exempt from Securities and Exchange Commission requirements due to go into effect next year that would force them to let their share prices fluctuate and allow them to impose liquidity restrictions.
But not all retail funds are going to drop municipal securities and corporate debt in order to protect their stable net asset values. BlackRock, for instance, said some of its money-market funds would maintain a focus on municipal securities. But those funds will focus on a type of debt, variable-rate demand notes, that pays off in an extremely short amount of time, within a week. BlackRock said those securities would “minimize” volatility and “significantly reduce the probability of the implementation of gates and fees.”
Legg Mason Inc. affiliate Western Asset Management, announcing its planned changes on Tuesday, said it will “adopt policies to impose liquidity fees, as well as provide for redemption gates” in its retail funds.
More such changes are expected before the October 2016 deadline to comply with the new rules.
When the rules go into effect, non-government money-market fund managers can impose fees on redemptions in times of market stress. They can also choose to restrict redemptions, known as a gate, in certain cases.
By designating the funds “retail,” managers can sidestep the requirement to let the fund’s net asset value float from $1 per share but at the cost of demonstrating that all the fund’s investors are individuals. Institutional funds will be expected to let their share prices fluctuate above or below $1, and also may allow liquidity restrictions.
Broker-dealers have pushed back on the idea of gates, according to the BlackRock executives who authored the letter, Tom Callahan and Rich Hoerner.
“Conversations with our retail distribution partners highlighted significant concern regarding funds that are subject to gates and fees for retail clients,” the BlackRock executives said. “Feedback from many of our retail partners currently using various BlackRock money funds for daily cash sweeps indicate it is uncertain that anything other than [constant-value] government funds will be offered for sweep accounts. The feedback stems from the cost of modifying systems to operate sweeps and the associated operational risk from implementing gates and fees.”
Some broker-dealers have abandoned money-market funds altogether, moving sweep assets in client accounts to bank-deposit programs, which pay returns similar to those on money market funds but are run through broker-dealers’ bank affiliates. Other investors and advisers have considered other types of products, from certificates of deposit to ostensibly riskier short-term bond funds, for some of their cash allocations.
The SEC reforms came in response to the market stress in 2008. At that time, the $62.5 billion Reserve Primary Fund, which was invested in Lehman Brothers debt, “broke the buck,” falling below $1 a share when that investment bank collapsed.