Reform Calls for Evaluation of Money Market Fund Strategy

Plan sponsors that offer money market investments in their defined contribution plans should start talking with their investment advisers to evaluate their money market strategy, says Robert C. Lawton.
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Aside from the need to regularly evaluate investment strategies anyway, certain money market fund reforms recently enacted by the Securities and Exchange Commission (SEC) require plan sponsors attention, Lawton, president of Lawton Retirement Plan Consultants LLC in Milwaukee, says in a blog post on his website. “Plan sponsors and participants look at money market funds as savings accounts because they feel  they can’t lose money, but that will change,” he tells PLANADVISER.

The SEC rule amendments, announced in July, require providers to establish a floating net asset value (NAV) for institutional prime money market funds, which will allow the daily share prices of these funds to fluctuate along with changes in the market-based value of fund assets. The rule updates also provide non-government money market fund boards new tools, known as liquidity fees and redemption gates, to address potential runs on fund assets.  Redemption gates limit the amount of withdrawals allowed from the fund during a specific period. Plan participants who are invested in stable value funds or guaranteed fixed-income products are used to such restrictions, but participants in money market funds are not, Lawton notes. “This will be something that catches participants off guard to a greater degree [than the use of a floating NAV],” he contends.

Lawton says these changes will not be implemented until the fall of 2016, so nothing is changing right now. “Plan sponsors seemingly have quite a bit of time to work with adviser on money market strategy.”

With a floating NAV, institutional prime money market funds (including institutional municipal money market funds) are now required to value their portfolio securities using market-based factors, and sell and redeem shares based on a floating NAV. The SEC says these funds no longer will be allowed to use the special pricing and valuation conventions that currently permit them to maintain a constant share price of $1.

According to Lawton, the thought process is these large fund companies, especially in a zero-interest-rate environment, have been subsidizing money market funds at considerable cost. The value of the fund is not reflected in the $1 price. “A NAV will give investors a better idea about which funds are weaker and which are stronger,” he says. “It’s a better way to facilitate transparency about which funds offer a better chance of not losing principal.”

Lawton believes the marketplace will gravitate toward funds that are stronger, and there will probably be a few surprises once the floating NAV is implemented.  In the low interest rate environment, some money market fund providers have already exited the business because the cost of subsidizing the $1 price is too high for them to sustain interest in the business, he says. With the threat of a floating NAV, more providers may exit the business. “If a fund company knows its value will be below $1, it may decide to get out of business before 2016 [the implementation date of rules changes], because it may start losing assets right away as soon as the conversion date occurs,” he explains.

On the other hand, Lawton thinks the money market fund business will look more appealing to fund companies if interest rates start to increase. He speculates this may be part of the reason the implementation date of the reforms is so far out, because it is in line with the Federal Reserve’s promise to boost interest rates.

“All plan sponsors have a choice when considering their ‘safe investment’—stable value, guaranteed fixed income or money market funds,” Lawton says.  Those that are concerned about the potential loss of principal on money market funds may ask advisers about one of the other options. It is also important to keep in mind that government money market funds are not subject to any of these changes, he adds. “So if you wish to continue to offer a traditional money market fund that isn’t subject to loss of principal, you can still do so.” According to Lawton, there are a number of 401(k) plan sponsors that have always offered government money market funds in their plans because they thought they were the safest. Plan sponsors still can offer $1-per-share investments with government money market funds.

However, some plan sponsors may consider that since the Fed is going to be increasing interest rates, and money market funds respond faster to rising rates than the other two options, it is in the best interest of participants to keep offering a money market fund. In this case, Lawton says, plan sponsors need to ask their advisers to look at the credit quality of the fund being offered. There may be a better fund. He explains that plan sponsors do not want the NAVs of their money market funds to fluctuate wildly and scare participants with the potential loss of principal.

In addition to developing their money market fund strategy with their investment advisers, plan sponsors can start sharing their strategy with participants in the education sessions they already hold, Lawton recommends.  “Most plan sponsors I work with have an annual employee education session at the beginning of the new year, usually because that is the time of investment fund changes, so it makes sense to me for plan sponsors to start talking with participants about it with their 2015 session, even if it is just to say ‘We are working with our adviser to make sure we offer you the best options,’” In 2016, plan sponsors can be more specific about their ‘safe investment’ fund approach, he adds. Participants also need to be informed of the new redemption fees and restrictions.

Lawton concludes that plan sponsors shouldn’t spend their time worrying about whether participant websites or call centers will be updated appropriately; they should ask their recordkeepers to take care of that. “Just focus on your money market fund strategy.”