By James Sanford
Editor’s Note: The Securities and Exchange Commission (SEC) just passed new rules that change the way money market accounts are valued, yet few investors understand how these rules can put their savings at risk.
Money market accounts are a $2.6 trillion industry that impacts nearly every investor who parks cash.
Most investors treat money market accounts like “savings accounts” where a dollar is worth a dollar, regardless of time. But under the new rules, money market funds will be priced as a floating system that reflects market movements. Money market funds used to be treated as fixed prices equal to $1 per share.
This new SEC law has large ramifications for investors yet there has been little context into how this impacts investors.
One of the proposed rule changes by the Securities and Exchange Commission (SEC) for money market funds, requiring a floating net asset value (NAV) rather than a fixed $1.00 par value, is a welcome addition to a new post-crisis reality. The other proposed changes which would allow money managers to suspend redemptions by investors, or charge them fees to redeem during volatile periods, are a travesty.
The fixed $1.00 NAV is a convenient shell game trick which completely hides the underlying volatility of the basket of securities in the portfolio, convincing the holder he owns a “cash equivalent” rather than a portfolio of risky corporate senior-unsecured-debt obligations, which despite their 7-, 10- or 90-day maturity, are equal in recovery/default risk to corporate long bonds maturing 10 and 30 years from now.
Usually the portfolio in a money market fund doesn’t move at all in price until a shock event hits one of the entities in the portfolio, which was the case of the Lehman Brothers default. Investors then all of a sudden realize they don’t own “cash”, and instead own risky corporate debt pari passu with other corporate debt, which in the case of Lehman Brothers, opened up Monday morning September 15, 2008 at a bid offer $10 – 12 cents on the dollar. Suddenly “cash” just lost 90 cents on the dollar.
There is an investor perception that their money market fund is insured by the manager due to the “break the buck” concept. In fact, there is absolutely no legal requirement or guarantee that money managers must “never break the buck” or shield investors from losses. Investors hold the risk bag in the end, while money managers fool them into forgetting that, by dangling this fixed $1.00 mark along with the “wink-wink” nod that the manager will insure the portfolio against losses.
Both features are false premises used to fool investors into thinking this is “cash” First, these underlying securities contain corporate credit risk-of-default like any other corporate bond. Second, there’s no legally guaranteed “par put” to the manager. The money manager industry knows that by allowing these funds to have a floating NAV, they allow the investor to take a bite from the apple of the tree of knowledge, and thus bring radical change to an industry that will never be the same again. Good- it should not be the same again.
The other key rule change which his is to allow money managers to limit investors’ ability to redeem the funds, or charge them extra fees for redemption, in periods of excessive volatility.
That begs the question- how do you call something a “money market”, thus giving it the metaphorical equivalent of cash, and limit investors’ ability to treat it as such? And how do you impose fees, like .25 percent on something that doesn’t even annually yield the amount of the fee? Why would we penalize investors for the completely rational thought process of selling securities during risky volatile times?
So what can an investor do and what advice would I give them as a financial advisor? Stay out of money market funds! The few extra basis points of yield aren’t worth it. Put your short-term money in FDIC guaranteed bank CDs. The yield differential isn’t worth taking the capital loss risk inherent in money market funds, and the FDIC is the only real insurance around. If the FDIC can’t honor its agreement, then we’ll be living in a Snake Plissken world and it won’t matter anyway.
James Sanford has worked with Credit Suisse Securities, JP Morgan Securities and Gleacher & Co. He is now the portfolio manager with Sag Harbor Advisors. www.sagharboradvisors.co. Phone No. 631-740-4498.