The Securities and Exchange Commission (SEC) amended its rule governing money market funds on July 12, 2023. These new amendments will significantly impact the $5.8 trillion money market fund (MMF) industry. Experts believe the institutional tax-exempt and institutional prime market money market funds will be mostly affected by these reforms by the SEC, with specific liquidity fee requirements.
A money market fund is a specific type of mutual fund investing in near-term instruments that are highly liquid. These instruments include cash, short-term debt-based securities, and cash equivalent securities. Money market funds are highly preferred investment options because they offer investors high liquidity and low-risk levels.
Understanding the SEC Amendments
Money market fund investors are generally after immediate liquidity without much volatility. As a result, they tend to get anxious when their expectations are not fulfilled because of market stress.
The money market fund sector was severely affected because of the impact of the pandemic in 2020. According to the U.S. Treasury, more than $130 billion was withdrawn by investors from money market funds during this period. Naturally, this put the short-term funding markets under tremendous stress.
Emergency liquidity facilities were launched by the Treasury and Federal Reserve to backstop the market and provide some relief to investors. This panic-stricken market condition was similar to 2008 when global markets showed signs of freezing up because of a run on money market funds. The SEC addressed the risk of investor runs by introducing changes in 2010 and 2014. However, critics suggest the 2020 turmoil indicates that the previous modifications needed revision.
The primary goal of the latest SEC amendments is to address the concerns related to the prime and tax-exempt MMFs, which have been particularly susceptible to market stress in the recent past.
- As per the previous rule, holding at least 10% and 30% of the funds’ total assets in daily and weekly liquid assets was mandatory, respectively. As per the amendment, these figures have risen to 25% and 50%, respectively. The SEC strongly believes that boosting funds’ liquidity will make it much easier to meet redemptions.
- The recent reforms state money market funds will no longer be able to impose temporary gates to suspend redemptions. Although no such curbs were imposed by any fund in 2020, regulators believe this apprehension may encourage withdrawals.
- All institutional tax-exempt and prime money market funds must now impose mandatory liquidity fees whenever their daily net redemptions exceed 5% of their net assets. Also, if the board of funds deems it necessary, a discretionary liquidity fee must be imposed.
- If money market funds with stable net asset values experience negative interest rates, they will have the flexibility to cancel shares or switch to a floating net asset value.
The SEC’s new fee framework aims to ensure fair allocation of costs so that the redemption cost is borne by the redeeming shareholders.
What the SEC Reforms Mean
While there have been widespread debates about the likely impact of the reforms made by the SEC, many industry experts agree the primary objective of these changes is to make MMFs more resilient, ensure the smooth functioning of the markets, and reduce the burden of taxpayers and investors during market disruptions.
At the same time, there have been significant efforts to maintain the usefulness of MMFs as cash management vehicles for retail as well as institutional investors.
Some people claim that new higher liquidity levels may reduce the ability of MMFs to achieve higher yields. However, investors are unlikely to be impacted in the short term. In response to the expected policy rate path of the Federal Reserve, MMFs are holding at significantly higher levels compared to the new requirements.
Only time will tell how this change will impact over a longer cycle.
The success of these changes to SEC rules depends on striking the correct balance between maintaining investor options and regulatory safeguards. A vibrant and accessible MMF market requires a middle ground where all systemic risks are addressed, without increasing the burden on investors and fund managers.
Investing in MMFs in 2023
The rising interest rates in 2023 is not good news for the borrowers. However, this is undoubtedly a favorable time for investing in money market mutual funds. While no investment is 100% risk-free, some money market mutual funds are typically considered lower-risk. The most critical task for investors is to find the right one for their portfolio.
Money market funds can be divided into three categories: government, prime and municipal.
Government funds invest in U.S. Treasury Securities, cash, and repurchase agreements collateralized by U.S. Treasury Securities.
Prime funds invest in certificates of deposit, commercial paper, repurchase and reverse repurchase agreements, and short-term securities issued by foreign and domestic corporations.
The majority of assets of municipal or tax-exempt funds are invested in federal income tax-exempted securities.
A broad spectrum of financial institutions offer money market funds, including banks, mutual fund companies, and brokerage firms. Some factors to consider before making an investment decision:
- To receive the best return on investment, comparing a fund’s yield to others is essential.
- All funds charge an expense ratio. Therefore, if all other factors are similar, opting for a lower expense ratio always makes sense.
- Deciding between a prime, government, and municipal money market fund is also critical. For example, investors in high tax brackets can benefit more from municipal MMFs.
- Whether buying or selling money market funds, investors should also pay attention to additional fees such as mutual fund commissions.
Although many money market funds are performing well, Vanguard money market funds have received notable market attention. The taxable status of Vanguard’s taxable money market funds does not apply to tax-deferred accounts. This makes them excellent retirement account options for 401(k) plans and IRAs.
Vanguard Treasury Money Market Fund (VUSXX), Vanguard Federal Money Market Fund (VMFXX), and Vanguard Cash Reserves Federal Money Market Fund (VMRXX) are three taxable Vanguard money market funds, each with a minimum initial investment of $3,000.
VUSXX has the lowest expense ratio of 0.09% of all taxable money market funds from Vanguard. It primarily invests in short-term U.S. Treasury bills while maintaining at least 80% of its assets in US treasury securities issued debts and repurchase agreements that are 100% collateralized by US treasury securities. The fund aims to maintain a stable net asset value (NAV) of $1, like other money market funds from Vanguard.
From an investor’s point of view, VUSXX is a conservative option because its shares are likely to remain stable or experience minimal fluctuations. The Vanguard Treasury Money Market Fund’s return is modest compared to some other MMFs; its stability can be a lifesaver amidst the current market uncertainties. Individuals looking to preserve their capital can benefit significantly from this low-risk investment.
This article was produced by Media Decision and syndicated by Wealth of Geeks.