The Securities and Exchange Commission is gearing up for a vote on proposed regulations for the money market industry. If approved, the regulations would require money market funds to either set aside a predetermined capital buffer or "float" their net-asset values.
The vote pits SEC Chairman Mary Schapiro, a fierce advocate for the regulations, against the financial industry, which remains vehemently opposed to them. One of the industry's biggest complaints is that the floating NAV would have a devastating effect on still-fragile money market funds.
There is, of course, some truth to this claim. In September 2008, money market funds had more than $3.5 trillion in assets under management. As of August 1, 2012, that number was $2.55 trillion. In other words, the industry is hurting and is still a long way away from recovery.
Floating NAVs would do little to help investor confidence, and instead would likely inspire outflows. But a separate question is: To a rational retail investor, should the floating NAV make much of a difference? It's too early to say for sure, but the answer at the moment seems to be "no."
First, some background. Money market funds currently have "stable" NAVs. That means that day in and day out, they report their value at precisely $1 per share. Not a penny more, not a penny less. Mutual funds, by contrast, have "floating" NAVs. At the end of each day, their price changes to reflect the value of their underlying investments.
In the context of money market funds, the difference between floating and stable NAVs once appeared largely academic. The belief, which grew stronger with each passing decade, was that money market funds were an entirely risk-free investment. That myth, of course, was shattered in September 2008, when the Reserve Primary Fund "broke the buck"—meaning that its value dipped below $1 per share. The fund's misfortunes stemmed from its hefty exposure to Lehman Brothers.
Since the Reserve Primary Fund fiasco, Schapiro has led the charge for increased regulations. She won a partial victory in 2010, when the SEC gave the green light to some regulatory changes that were largely cosmetic in nature. But she recently told Congress that more needs to be done.
"The risks posed by money market funds to the financial system are part of the important unfinished business from the financial crisis of 2008," Schapiro told the Senate Banking Committee in June. "Although the Commission took steps in 2010 to make money market funds more resilient, they still remain susceptible today to investor runs with potential systemic impacts on the financial system, as occurred during the financial crisis just four years ago."
Schapiro's goal in pushing for the floating NAV is greater transparency. In truth, the stable NAV is an illusion. At any given moment, a money market fund's true value may diverge by a fraction of a cent from $1 per share. Schapiro hopes that seeing these fluctuations will help investors get used to them and see them as normal rather than as an aberration. This, in turn, could reduce the possibility of debilitating outflows in tough times.
For its part, the financial industry fears that this lesson could come with a steep short-term price tag and could indeed cause some of the panic that Schapiro is seeking to avoid. The Association for Financial Professionals, for instance, has said: "We oppose the proposal to eliminate the stable NAV in favor of a floating NAV, as we believe it would greatly reduce investors' interest in utilizing [money market funds] as a cash management and investment tool . . ."
While it is true that many investors may get spooked by looking under the hood of money market funds and actually getting to see the fluctuations that the stable NAV masks, conscientious investors should think twice before reflexively abandoning money market funds.
That's primarily because floating NAVs probably will reveal little in the way of actual surprises. The Wall Street Journal reported in March on the experience of a Deutsche Bank money market fund that voluntarily opted to float its NAV. The fund's target price is $10 per share (a departure, largely for aesthetic and mathematical reasons, from the standard $1 per share of stable NAV funds).
Here's what the WSJ found back in March: "[O]ver the past year the price fluctuation has just been from $10.001 to $10.000, even amid the European crisis, debt ceiling debate and Standard & Poor's downgrade of U.S. government debt."
This is likely going to be the experience of the overwhelming majority of funds that would float their NAVs. Any deviations from the target NAVs would likely be so small as to be statistically insignificant—at least for retail investors who don't have enough money tied up in the funds such that infinitesimal fractions of a cent would make a difference.
Ultimately, at least in the short term, fund providers and other members of the financial industry are right to fear that a floating NAV would lead to outflows. But in the long term, there's reason to believe—or at least hope—that investors would begin to accept the fluctuations for what they really are: blips on the radar.